Grim new EU numbers mean governments and central banks will keep running the economic show

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Europe’s pandemic-induced heart attack was dire, and the patient will linger in the recovery ward for longer than expected a couple of months ago.

That, in essence, was the conclusion Tuesday of the European Commission, the executive arm of the European Union. The EC downgraded the GDP forecasts for EU and euro zone countries for both 2020 and 2021 and warned that all bets are off if a second pandemic wave hits, as it just did in southeast Australia – Melbourne is back in lockdown.

The prospect of a deep, enduring recession may come as a shock to a lot of investors, who had clearly expected a quick, V-shaped recovery. The stock markets have soared since their collapse in March, when countries around the world imposed national quarantines. They sold off on Tuesday, after the EC delivered its grim news and big-name investment shops such as BlackRock Inc. downgraded their outlook for equities.

It may also come as a shock to central bankers and finance ministers, whose lavish stimulus measures, bailout loans and income-support programs have prevented the recession from turning into an outright depression. Governments and central banks were the only game in town when vanishing sales and profits meant companies couldn’t finance themselves and keep paying their employees. They will have to stick around for a while.

At what point will Western central banks and governments follow the Japanese model and take a deeper plunge into the economic pool? The Bank of Japan is already the biggest buyer of exchange-traded funds (ETFs) on the Tokyo bourse and is close to overtaking the state-run pension plans as the stock market’s top buyer of Japanese equities. Central banks in Europe and North America may have to make a similar move to preserve wealth.

The EC said GDP in the EU will shrink 8.3 per cent this year; the spring forecast had called for a 7.4-per-cent drop. The 19 EU countries in the euro zone will perform even worse, with an expected GDP plunge of 9.7 per cent, grimmer than the previous forecast of 8.3 per cent.

Italy, Spain and France – each of which was hit hard by the pandemic – will be the worst performers in the EU, with GDP contractions this year of about 11 per cent. Britain (no longer in the EU) will see its economy shrink by just under 10 per cent, assuming it gets a trade deal with the EU by the end of the year; if it does not, its recession will no doubt deepen.

Germany is one of the few EU countries where the recession is moderating. The EC expects the German economy to shrink 6.3 per cent in 2020; the previous forecast called for a 6.5-per-cent contraction.

A recovery is coming in 2021, the EC said, but it won’t be enough to fill in the 2020 hole. It expects the EU to expand 5.8 per cent next year, down from its earlier forecast of 6.1 per cent. The revisions for this year and next reflect the slow reopenings.

In a statement, the EC said “GDP is forecast to fall substantially in the second quarter of 2020. … The scale and duration of the pandemic, and of possibly necessary future lockdown measures, remain essentially unknown. The forecast assumes that lockdown measures will continue to ease and that there will not be a second wave of infections.”

Most European countries have reopened their borders. Hotels, bars and restaurants are lurching back to life. Sicily is so desperate for visitors that its government is subsidizing holidays for Italians and foreigners. But several European countries have recently imposed local lockdowns. Spain has quarantined parts of Galicia and Catalonia. A spike in cases pushed the city of Leicester, in England, into a new lockdown. Germany quarantined a town in North Rhine-Westphalia after a massive outbreak at a meat-processing plant.

Over all, the infection, fatality and ICU numbers in Europe have plummeted. Italy had only about 70 ICU patients this week, down from more than 4,000 at the peak in early April, when its hospitals were overwhelmed. But the numbers could rise, triggering more local lockdowns. If that happens, economists will be busy downgrading their forecasts once again.

The deep, prolonged recession means governments and central banks will be running the economic show for a long time. Big companies on the verge of collapse will have to be nationalized (the German government is taking a 20-per-cent stake in Lufthansa in exchange for a €9-billion [$13.8-billion] bailout). The EU will have to accelerate the launch of its €750-billion recovery fund, a mix of grants and loans that will be handed to member states to rebuild their economies. Income-support programs will have to be extended. Central banks may have to buy equities to boost the stock market if investors take fright.

In March, the hope was that the pandemic would burn itself out by the summer. It didn’t; in some parts of the world, it’s intensifying and pushing governments and central banks into overdrive. Welcome to the ultimate socialist economy.

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