European consumers still firmly in the woods

All eyes on the European consumer: Private consumption is key in determining the shape and speed of the Covid-19 recovery. Given the sharp setback in consumer spending in H1 2020, which far exceeded anything seen during the Great Financial Crisis as well as the Eurozone debt crisis, without a meaningful rebound in private consumption, economic recovery prospects will remain rather dim.

Figure 1: Maximum drop in Eurozone private consumption relative to pre-crisis level

This explains the widespread excitement about the apparent V-shaped recovery in European retail sales that has materialized since governments across the region lifted lockdown restrictions from late April onwards. Several major European economies including heavyweights such as Germany, France, the Netherlands and the UK have returned to or even exceeded February - i.e. pre-crisis - retail sales levels.

Figure 2: Retail sales, except motor vehicles, Index: Feb 2020=100

Strikingly, the pace of the current retail recovery far exceeds what we saw in the wake of the Great Financial Crisis and the Eurozone debt crisis.

Figure 3: Eurozone retail recoveries in comparison (Index: 100= pre-crisis level, in months)

But a V-shaped retail recovery in the immediate crisis aftermath does not make a V-shaped private consumption recovery. In particular, we see three reasons why the consumer recovery in Europe will look quite detached from the trend in retail trade:

1. Retail sales ≠ private consumption: In fact, retail sales are not a very good proxy for the pulse of the consumer. After all, they make up only around 45% of private consumption, with the remainder consisting above all of housing-related expenses as well as services. It is the latter (around 25% of the total) that will be disproportionately more affected in the current crisis as “social expenditure” is cut back out of lingering contagion fears.

Figure 4: Consumer confidence: Dec 2019 vs. latest available

A better gauge for private consumption prospects is therefore consumer confidence, which still remains quite depressed, registering below the long-term average across European economies, alongside sky-high saving intentions.

Figure 5: Eurozone consumer confidence  - Savings at present (rhs) vs. savings next 12m (lhs)

2. Doomed durables – prepare for a W-formation in retail trade: The sharp rebound in retail trade has been propped up by a temporary boost in durable goods, which is unlikely to continue. For instance, furnishings and recreation & culture goods proved quite resilient in Q2 as consumers spent more of their disposable incomes on beautifying homes and gardens and setting up virtual offices during the lockdowns. Moreover, the temporary VAT reduction in Germany added additional tailwind. However, we don’t think that spending on these durables (around 11% of total private consumption), which tends to be closely related to the cycle, can remain immune to the Covid-19 downturn for much longer.

Figure 6: Eurozone private consumption by component (% of total)

This is particularly true with unemployment set to rise further over the coming months as income-support schemes are phased out and insolvencies are expected to pick up. In fact, it is time to acknowledge that even without a meaningful second infection wave the V-shaped rebound in retail trade will turn out to be solely the first leg of a W-shaped recovery formation.

3. Mind the Covid-19 specific consumption headwinds: In addition to the usual recession victims such as cyclical durables but also clothing & footwear, the peculiarities of the Covid-19 downturn, i.e. ongoing contagion concerns, will continue to put additional consumption components under immense pressure. Covid-19 sensitive spending centers on “social expenditure” and therefore includes transportation, restaurants & hotels and recreation & culture services. These vulnerable components represent almost one fourth (23%) of total private consumption in the Eurozone.  A return to pre-crisis spending patterns will therefore hinge on the availability and wide distribution of a vaccine.

Taking together these findings, what does that mean for the recovery outlook across European economies? Adding up recession and Covid-19 sensitive sectors as a share of national GDP underlines the highly divergent recovery prospects across Europe. After all, the sum of consumption components at risk during the current downturn range from 13% of GDP in Belgium to twice that with 26% in Greece. Interestingly our calculations see a greater risk for the private consumption recovery in Greece, Portugal, Spain and the UK than in Italy.

Figure 7: Recession and Covid-19 sensitive consumption components (% GDP)

What will be the impact on corporates? The recovery in activity seen across many consumption-driven sectors is likely to be short-lived. Retailers, in particular, should not expect a full-fledged and sustainable recovery in retail sales. The post-lockdown retail surge, which saw consumers to some degree make up for lost time, will progressively fade away and consumers will start to feel the bite of rising unemployment. Meanwhile, profit margins will continue to suffer from rising price pressures and the extra costs associated with running stores amid a major sanitary crisis.