As Q1 GDP reports emerge, the divergence is clear. The US grew strongly while the Euro zone recorded a second negative quarter. The UK, not reported yet, was likely down too. The stellar performance in the US reflects the huge fiscal stimulus, while weakness in Europe is due to tight social restrictions. The markets are already looking forward to strong growth everywhere from Q2 onwards, as Europe’s vaccine roll-out accelerates.
US at 99% of Q4 2019 levels
US Q1 GDP rose 6.4% at an annual rate (about 1.6% Q/Q). This was enough to restore GDP to 99% of the level of Q4 2019, pre-Pandemic. The numbers are even better than they look because both consumption and investment surged more than 10% (annualised rate) and the GDP figure was pulled back to 6.4% only because production couldn’t keep up, forcing a big drawdown of inventories (subtracting 2.6%). Imports also rose more strongly than exports, again reflecting the heavy demand for goods.
Drawdowns in inventories are usually followed by good GDP numbers in following quarters as business seeks to replace them. Q2 GDP should be another strong number anyway because President Biden’s fiscal stimulus of $1.9 trn will boost spending. Also, social restrictions are likely to be reduced further with the vaccine programme expected to cover all adult Americans by end-June.
Much less stimulus in H2
There is more of a question mark over the second half of the year. Continued inventory rebuild should help, as should growing confidence in visiting indoor venues. Also, the more than $2trn dollars in accumulated savings over the last 15 months should gradually be spent, with the outlook improving and jobs gaining. But the repeated fiscal infusions of recent months will come to an abrupt end so incomes will decline (even with expected good jobs growth). President Biden’s next two packages – the $2 trn American Jobs Plan and the roughly $2 trn American Families Plan – have yet to pass through Congress and, in any case, the money will be spent over many years and will be offset by higher taxes.
We still expect US GDP to grow in the second half and into 2022 but it will be at a slower pace than the last 12 months. Nevertheless, the US is on track to return to its pre-Covid trajectory and possibly above by end 2022, due to all the fiscal and monetary stimulus. Hence our concerns about inflation over the medium run. High reported inflation over the next few months likely will prove transitory as the Fed argues, but the worry is that inflation could strengthen again in 2022-3.
Euro zone double dip
Meanwhile the Euro zone suffered a second quarter of decline in Q1, marking a double-dip recession. The total decline over the winter was about 1.3% of GDP, far less than the 15% slump last Spring, but leaves the euro zone at 94.3% of Q4 2019 levels. Germany was the main cause of the latest decline, with GDP down 1.7% (Q/Q). Spain and Italy were also down slightly while France recorded growth of 0.4%. These results roughly align with social restrictions, as Germany was forced to lock down far more than before as Covid cases rose while French President Macron fought to keep the economy open despite rising cases, only tightening restrictions late in the quarter.
Europe’s vaccine programme is a couple of months behind the US and UK though it has accelerated in recent weeks. The Euro zone also has much less fiscal stimulus in place than the US and less than the UK too (see chart). The European Eur750bn package, called ‘Next Generation EU’ (which is in addition to the numbers in the chart) will only be spent gradually over several years. Europe’s trajectory is therefore expected to be slower than the US.
UK running between the US and Euro zone
The UK will report Q1 GDP on May 12 and it is likely to be down 1-1.5% reflecting the strict Q1 lockdown. This will leave reported UK GDP at only 91-92% of Q4 2019 levels. However, as I have argued in previous blogs, the UK GDP level, as reported, is not comparable with other countries because public sector output is estimated on a results basis, not on salaries paid, as with the other countries. With schools closed and non-Covid medical procedures cancelled, the Office for National Statistics marked down British GDP sharply. On a comparable basis the UK’s position is probably similar to the euro zone at about 94-95% of Q4 2019 levels.
From Q2 onwards, the UK should see a very strong recovery, taking it above Euro zone levels rather quickly. This will be due to the rapid vaccine rollout and strong fiscal stimulus, together with the ONS marking up official sector output with schools reopened and the NHS starting to catch up on the huge backlog of operations. The UK is also likely to return to its pre-Covid trajectory.