Economic recovery loses momentum; measures help keep labour market solid

The economic recovery in the euro area has lost momentum in the autumn, as a result of the growing deterioration in the epidemiological situation. At Banka Slovenije our assessment is that the crisis in the euro area would be significantly deeper without the countercyclical response from economic policy, the like of which is unprecedented in peacetime. The situation is very similar in Slovenia, where the outlook has deteriorated rapidly in recent weeks. The new Economic and Financial Developments reiterates that the situation on the labour market remains solid for now, under the influence of the government’s emergency measures.

After rising between May and July, the current indicators of economic activity in the euro area are deteriorating again, and the failure for now to contain the virus will have an even greater impact over the coming months. Amid a further downturn on the labour market, the declining confidence of consumers and firms will continue to depress domestic demand, thus increasing the risk of the realisation of international institutions’ latest forecasts of economic contraction. Deflationary pressures are also expected to strengthen.

Economic policy responded quickly and comprehensively to the crisis. The fiscal response from euro area countries has been profound: the European Commission has estimated the increase in their general government expenditure at close to EUR 540 billion. At the same time the Eurosystem had injected close to EUR 2,000 billion of additional liquidity into the economy by 25 September of this year via its longer-term refinancing operations and extensive asset purchases, while the new multiannual financial framework and the Next Generation EU instrument worth more than EUR 1,800 billion are in the process of being approved.

In Slovenia the economy continued its rapid recovery in the third quarter, which began after the strictest containment measures were lifted in May. Amid the strong economic policy measures, the response from economic entities to this year’s coronavirus crisis going into the autumn was different to the previous financial crisis: households did not refrain from purchases of durables over the longer term, and firms built up their inventories.

The situation in foreign trade is worse than on the domestic market, the recovery having drawn to an end over the summer. Numerous categories of goods have seen exports stop growing. The restrictions on travel and the changes in people’s behaviour are even more of a hindrance to the recovery in services trade.

Similarly to the euro area overall, the outlook has dramatically worsened in recent weeks. The most vulnerable sectors will again be services where direct contact between the provider and customer is essential, while the rising uncertainty will only further delay firms in their investment decisions.

The labour market situation remains solid amid the decline in GDP and the huge uncertainty. The monthly falls in employment came to a stop over the summer, while unemployment also underwent a sustained fall after peaking in May. Registered unemployment stood at 84,000 at the end of September, only 6,000 more than before the declaration of the epidemic, although it is highly likely to rise towards the end of the year.

Because the emergency measures prevented most of the contraction in GDP from being transmitted to the labour market, the year-on-year decline of 15.8% in the number of hours worked is perhaps a more pertinent indicator of the situation in the second quarter of this year, rather than the fall in employment of just 1.9%. The impact of the new crisis has so far mainly been felt most acutely by younger generations and workers in precarious employment. Growth in the average monthly wage remains high relative to the level of economic activity.

Consumer prices have seen deflation in recent months, and this continued in September. The largest factor in the year-on-year fall in prices of 0.7% was again a fall in prices of refined petroleum products. In the wake of slower growth in global prices of food commodities, food price inflation has also slowed since May, but nevertheless remains high, driven primarily by rises in prices of fruit. There are also domestic deflationary pressures in the form of weaker private consumption and diminishing utilisation of production capacity, which are reducing core inflation.

The pandemic is having a huge impact on the public finances, and future fiscal developments are subject to numerous uncertainties. The general government deficit in the first half of this year amounted to 11% of GDP. General government revenues declined by slightly more than nominal GDP, while growth in general government expenditure was high, largely as a result of the measures under the anti-coronavirus laws. The general government debt amounted to 78.2% of GDP at the end of June, up 12.6 percentage points on the end of last year. The terms of borrowing remained favourable, thanks to the ECB’s highly accommodative monetary policy, and also the solidity of Slovenia’s macroeconomic position compared with many euro area countries, which is a positive factor in its sovereign credit rating.

Figure 1: Registered unemployed and number of employees included in furlough scheme and subsidised short-time work

Note: The number of employees included in the two government emergency measures is based on applications processed by 13 October 2020. Sources: SORS, Employment Office, Banka Slovenije calculations

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