Reasons for Optimism

Economic sentiment in the Eurozone is reaching new heights, suggesting the long-awaited recovery is finally gathering speed. However, risks remain due to the spread of COVID-19 variants leading to new restrictions and scarcity of input factors for the European industry.

The easing of virus containment measures is putting EU economies back in motion. The near-term outlook for the European economy looks brighter than expected in spring. The GDP contraction in the first quarter of the year turned out to be marginal, and milder than suggested by Eurostat’s Preliminary Flash Estimate.

Survey results among consumers and businesses are upbeat, while data tracking mobility suggests that a rebound in consumption is already happening and will strengthen in the coming months. Tourism also seems on the cusp of a revival, which should get a boost from the new EU Digital COVID Certificate. These factors are expected to offset the temporary production input shortages and rising costs hitting some parts of the manufacturing sector.

The major early economic indicators for the Eurozone have reported values unseen in years, if not decades. The Purchasing Managers’ Index for August indicated that the Eurozone grew at the fastest rate in the last 15 years, even though it eased from the record expansion registered in June.

This is due to two developments. First, the export-oriented manufacturing sector benefitted from booming world trade. Second, the Eurozone’s services sectors have recovered strongly. This is welcome news for the southern European countries, which rely heavily on tourism.

Economic sentiment has rebounded from the lows of last autumn and winter. In August, the EU indicator was 27.3% higher than in September 2020. Malta has the highest improvement of the countries shown in the chart, with an ESI 30% higher over the same period. 

The Central Bank of Malta’s Business Conditions Index has recovered in 12 months all the ground lost in the previous two years, no doubt buoyed by the general easing of COVID containment measures. This indicates that the fear that the crisis would have long-lasting negative effects and result in consumer hesitancy seems to have not materialised.  

A similarly positive trend is evident from employment expectations. The seasonally-adjusted three-months forward indicator also shows a strong recovery from November 2020, when Malta had the worst employment expectations of the five countries concerned.  Expectations in August in Malta were as good as those in the EU.

Overall, GDP is now forecast to grow by 4.8% in 2021 and 4.5% in 2022 in both the EU and the euro area. The volume of output is projected to return to its pre-crisis level (2019-Q4) in the last quarter of 2021, which is one quarter earlier than expected in the Spring Forecast for the euro area. However, economic activity in the fourth quarter of 2022 would remain about 1% shy of the level that was expected before the pandemic, based on an extrapolation of the Winter 2020 Interim Forecast. The speed of the recovery will vary significantly across the Member States. Some are expected to see economic output return to their pre-pandemic levels by the third quarter of 2021, but others would take longer.

The European Commission expects Malta’s GDP to grow by 5.6 percent (EU: +4.8%) this year, after last year’s 7.8 percent contraction (EU: -6.0%) and pick up further to 5.8 percent in 2022 (EU: +4.5%).  Malta’s forecast is 1 p.p. better than what it was in the spring forecast. The better growth outlook is driven by the strong performance in the first quarter, which has a strong carry-over effect, and the positive picture painted by recent confidence indicators. It also adjusts the recovery path for the downward revision to 2020 GDP growth. The forecast for 2022 is similarly strong, which means that Malta’s economy is expected to reach pre-pandemic levels of activity around mid-2022.

A rise in inflation across Europe

A side effect of the recovery underway is a rise in inflation. In the Eurozone, the annualised inflation rate in August stood at 3.0%. This is hardly runaway inflation, but is a significant change nevertheless. The last time the Eurozone’s inflation rate was above the European Central Bank’s (ECB’s) 2% threshold was in 2012; deflation has been the biggest worry for monetary policymakers for the most part of the last decade.

But not so in Malta. In fact, our annualised inflation in August was estimated at 0.3%, the lowest in 19 member states which reported, and has been consistently significantly lower than that in the Eurozone since March. HICP inflation has increased moderately since January, but the increase in energy and imported goods prices and a recovery in the tourism and hospitality sectors are set to increase price pressures in 2021. After picking up to 1.1% in 2021, inflation (HICP) is expected to reach 1.6% in 2022, compared to a eurozone forecast of 1.9% in 2021 and 1.4% in 2022.

Our annualised inflation in August was estimated at 0.3%, the lowest in 19 member states.

However, this does not necessarily signal a shift to a permanently higher level of inflation. First, current developments appear to be mostly driven by temporary factors. Energy prices especially have increased substantially in recent months and a sudden yet temporary release of pent-up demand from consumers in the upcoming months could further push prices higher due to capacity constraints.

Uncertainty and risks surrounding the growth outlook are high but remain overall balanced. The threat posed by the spread and emergence of variants of concern underscores the importance of reasonable containment measures and administration of vaccine boosters. Economic risks relate in particular to the response of households and firms to changes in restrictions and the impact of emergency policy support withdrawal.

Further economic stimulus will come from the European Recovery Fund, which is about to release its first tranche of money. The €750 billion fund, based on joint debt, was established a year ago to help EU member states recover from the COVID-19 recession and make European economies greener and more digital.

Malta has requested a total of €316.4m in grants, to be spent on six areas, including sustainable transport, circular economy, clean energy and energy-efficiency in buildings, digital transformation of the public administration and the legal system, projects targeting the health and education sectors, as well as institutional reforms. Projects in the plan cover the entire lifetime of the RRF until 2026. The plan proposes projects in five of the seven European flagship areas.

The European Union expects that the programme will lift European GDP by 1.2% in 2021 and 2022. Taking a longer perspective, Standard & Poor’s estimates that the effects will be somewhere between 1.5% and 4.1% of GDP until 2026. Malta, like other southern Mediterranean states, can be expected to get rather more mileage out of each euro spent. At its peak, the plan is expected to boost Malta’s GDP by over €110 million and add nearly 700 new jobs.

By the time Minister Clyde Caruana presents this year’s Budget in early October, we may well have heard from the Commission whether it has approved Malta’s Recovery Plan programme. All indications are that the Budget will be geared towards resumed economic expansion, with a strong emphasis on capital expenditure, and balanced by continued improvement in social services.

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