Eurozone & Japan: Paths diverge

The path of the pandemic has diverged between the Eurozone and Japan into mid of the year.
Radhika Rao, Ma Tieying27 May 2021
  • Better vaccination rates are a key differentiator in dictating the extent and pace of recovery
  • Rise in global yields is a watch factor especially if the taper talk gathers steam
  • High debt levels remain a point of vulnerability
  • Domestic inflation will strengthen vs 2020, but not a bother for policymakers
  • We dial up Eurozone GDP growth to 4% y/y and flag risks for Japan
Photo credit: Unsplash


The Eurozone has witnessed a turnaround in recent months, predominantly led by the improvement in the pandemic situation. Caseloads have peaked in most member countries, especially the Core-4, containing fatality and hospitalisation rates. Restrictions are easing but gradually, for instance, Germany has allowed few contact-intensive services to reopen, whilst some parts of the continent are open for cross-border travel. New and vaccine-resistant variants are, however, a risk, which has seen authorities exercise considerable caution in the reopening process.

After a slow and hesitant start, the vaccination pace has accelerated. Daily inoculations in Germany, France, Spain, and Italy have surpassed the US into May. About 30-40% of the respective populations have received at least the first dose and expectations are that a critical mass will be covered by 3Q21, subject to sufficient supplies.

Growth is receiving a fillip after a difficult 2020. Encouragingly, considering the stringency of the measures in 2H2020 and 1Q2021, the decline in activity was milder than during 1H2020’s wave as the linkage between mobility and growth pace weakened. This owed to an extended period of accommodative policy, adept households’, and business to subsequent lockdowns as well as tailwinds from stronger global growth. The European Commission recently raised their 2021 growth forecast to 4.3% vs 3.8% earlier, fully reflecting the likely economic impact of the Recovery and Resilience Facility into the math.

1Q21 GDP contracted by a smaller -1.8% y/y (-0.6% q/q sa), with France’s sequential growth returning to black, while Italy notched the most improvement. On-track reopening will help income and employment uncertainty to fade, which along with additional buoyancy from tourism, external trade and easy financing conditions buoying investments, will be crucial legs for growth this year, provided infection rates remain under control and vaccine rollout achieves critical mass in 2H21.

We are dialing-up our 2021 forecast to 4.0% and 2022 to 4.2% to capture the anticipated turnaround in activity and forward-looking optimism. In terms of level GDP, compared to pre-pandemic trends, there is still some catch-up to do, as -6% contraction in 2020 will be followed by a softer bounce this year.

A combination of cost-push pressures, temporary factors (tax changes), base effects and re-weighting of the price basket, has driven inflation higher in recent months. This might be fuelled further by a return in the demand impulses and high service sector pressures as economies reopen.

April inflation ticked up to 1.6% y/y vs Jan’s 0.9% and might surpass 2% in 2H21, above the central bank’s target. Yet policymakers are likely to see this jump as transitory given that output is below pre-pandemic levels and there is slack in the labour markets.

The European Central Bank will be in a tough spot, reflecting optimism in their economic outlook but need to prevent financial conditions from tightening up. Bond yields have risen from late-2020 lows, especially widening Bund-Italian spreads, even as US treasury yields have stabilised. Nonetheless there are certain ECB factions which backs a plan to lower monthly asset purchases from 3Q and allow the program to run out in Mar22. Financial market gauge for inflationary expectations, year-to-date, has risen more than the US, tracking better growth prospects as well as higher supply-side drivers namely commodity prices and rising input costs. Any guidance on taper in asset purchases is not the cards this year, with the US Fed expected to frontrun the Eurozone policymakers in this regard.

Fiscal deficits are unlikely to meaningfully correct in 2021 despite an upward revision in growth projections, as emergency policy support and higher expenditure stands extended in most cases. The Eurozone’s deficit is expected to rise to 8% of GDP vs -7.2% in 2020, with overall public debt also set to rise to a new record of 102% from 98% last year, underpinning bond supplies. Looming elections in key member states will also have a bearing on the timeline to reinstate the suspended debt brakes, beyond 2022.


After contracting 5% QoQ saar or about 2% YoY in 1Q, the Japanese economy is expected to stay stagnant in 2Q and recover moderately in the second half. Our full year GDP growth forecast for 2021 remains at 2.8%, but risks are skewed to the downside.

The main challenge comes from the new highly contagious virus variants, which have caused the fourth wave infections in the populous Japanese cities and triggered the third state of emergency. It does not help that the pace of vaccination remains slow, due to the shortage in global vaccine supply. Only around 5% of population has been inoculated as of end-May.

The resurgence in coronavirus has weighed on confidence, discouraged consumer spending on non-essential goods and services, and aggravated consumers’ deflation expectations. Meanwhile, it also dampens hope for the Tokyo Olympics Games to boost tourism and consumption in 3Q. A prolonged period would be needed for private consumption to recover to its normal levels seen before the 2020 pandemic outbreak and the 2019 sales tax hike.

The key driver for GDP growth remains exports. The acceleration of vaccination in the US and other developed economies bolsters the case for a further recovery in global trade activities in the second half of this year. The deterioration of the pandemic crisis in India and other emerging economies may depress smartphone and automobile demand. But it would also spur demand for the consumer electronics products that support remote work and homeschooling.

In face of a delayed economic recovery and lingering deflation, the Bank of Japan is likely to lag other major central banks to normalise monetary policy. The BOJ has kept the door open for further policy easing. It established an Interest Scheme to Promote Lending at the March policy meeting, paying 0.1%-0.2% interest to the financial institutions that tap its cash coffers to boost loans. This scheme provides some leeway for the BOJ to further cut the negative policy rate, if necessary.

The government is still inclined to inject more fiscal stimulus into the economy, through the existing contingency reserve funds and the supplementary budgets. In addition to the economic pressure stemming from the pandemic, Prime Minister Yoshihide Suga and the ruling Liberal Democratic Party would also face greater political pressure in the next several months, in the context of a Lower House election that must be held before October.

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Radhika Rao

Economist – India, Indonesia, Thailand & Eurozone

Ma Tieying 馬鐵英, CFA

Economist - Japan, South Korea, & Taiwan 經濟學家 - 日本, 南韓及台灣

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