Macro insights

Coronavirus an obstacle to euro area recovery

The euro area ended 2019 with GDP essentially stagnating. Sentiment data had started to improve in recent months. But this tentative recovery could stumble due to the coronavirus outbreak and the spillovers from efforts to contain it.

Sources: BlackRock Investment Institute and the Organisation for Economic Co-operation and Development, February 2020.  Notes: The chart shows the goods and services that each country or area exports to China as a percentage of local GDP, using trade in added value data from the OECD, as of 2016.

The euro area is more exposed to Chinese export demand than the U.S. See the chart above. And it has extra exposure to China through foreign affiliate sales, especially in the car industry. But the euro area also relies less on intermediate inputs from China in its domestic production than the U.S. or Japan, making it less susceptible to any supply chain disruptions.

At the same time, exports to China were already expected to take a hit even before the outbreak: the “phase one” deal between the U.S. and China will divert significant Chinese demand away from the euro area. According to January 2020 estimates by the Kiel Institute for the World Economy, exports to China will probably be $10.8 billion lower in 2021, with the euro area likely bearing about a sixth of the trade diversion via aircraft manufacturing, auto production and capital goods. Germany would be the hardest hit country. The European Central Bank would be challenged to respond to any material damage to the region’s economy given that it has much less monetary policy ammunition compared with the Federal Reserve.

Spillovers from the coronavirus pose the biggest short-run risk to a euro area recovery. The global economy is vulnerable to the knock-on effects of measures to contain the outbreak transmitted either through global supply chains or demand for travel and hospitality. The hit could come either via a supply shock: intermediate inputs from China are held up in mainland China, bringing production to a halt elsewhere. Or it could come via a demand shock: Chinese demand for goods and services from the rest of the world drops sharply. While both shocks would hurt activity, the negative supply shock will limit disinflationary pressures – and if it were the dominant shock, it could even spark inflationary ripple effects.