>> GROUP: Shadow ECB Council / EZB-Schattenrat  Katharina Utermöhl

Katharina Utermöhl: Question: What impact from the coronavirus do you expect for the eurozone economy?

>> Marked but temporary growth setback in H1 2020 with elevated recession risk for Germany, France and Italy

To take into account the likely economic fallout related to the Covid-19 outbreak, we have lowered our 2020 Eurozone forecast from 1.0% to 0.6%. However, despite the marked downgrade, risks to our outlook remain skewed to the downside. The sharp cut in our forecast was largely driven by Covid-19 spreading throughout Europe, as the region has become the second most affected after Asia. Hence another transmission channel was added beyond exports, supply chains and tourism, namely the containment measures put in place to slow the spread of the virus – whether implemented by the government or self-imposed by individuals. In that context in particular private consumption – the backbone of the Eurozone upswing in 2019 – is bound to take a notable hit as festivals, fairs and sports events have been cancelled. Overall the eurozone economy will experience a marked growth setback in the first half of 2020 with a heightened risk that economic heavyweights including Germany, France and Italy will slip in a technical recession or at least register one quarter of negative GDP growth. Our baseline scenario envisions a gradual recovery to start to unfold in late Q2 with some catch-up effects in the second half of 2020.

Question: What should the ECB do against the economic impact of the coronavirus crisis?

>> A 10bp rate cut is a given at this point to stabilize sentiment, but only targeted fiscal measures can alleviate the economic fallout

Global policy makers have notably stepped up their response to the Covid-19 outbreak over the past week as fears about the economic and financial market impact are mounting. In particular central banks around the globe have started to put their money where their mouth is, with the US Federal Reserve, the Bank of Australia, the Bank of Canada and the Bank of Japan easing their policy stance. These steps come on top of an already strong response by the People’s Bank of China since the beginning of February. The Fed’s 50bps emergency cut however stands out as it has put notable pressure on reluctant peers to follow suit.

The uncoordinated manner of global policy easing – with the G7 statement not mentioning monetary policy action – reflects marked differences when it comes to central banks’ remaining policy room for maneuver. As a result the ECB – with the deposit rate presently already at -0.5% – will have to respond to the Fed on its own terms. At the upcoming March meeting we expect a 10bps cut in the deposit rate to -0.6%. In addition, measures aimed at ensuring there is enough liquidity should be stepped up, which could include a further relaxation in TLTRO-III terms as well as targeted liquidity support for companies affected by the Covid-19-related economic fallout – in particular SMEs. A further increase in the monthly rate of QE purchases is likely to be saved for later this year, as the ECB will want to keep some powder dry for now. Should for instance corporate credit spreads start to widen, then the ECB could increase the monthly QE flow and tilt purchases more towards corporate bonds.

The ECB should cut rates next week to prop up sentiment, but the impact on growth will be pretty muted. Blanket monetary policy action such as lower rates may help prop up market confidence and prevent an undue tightening of financial conditions but is unlikely to help address disruptions of production and supply chains or convince people to spend more if they are afraid to leave their homes. Instead targeted fiscal policy measures - as opposed to blanket tax cuts or spending increases – are more appropriate to stabilize the economy as they can work more quickly than monetary policy and help those that are most affected. Measures announced in China, Hong Kong and Italy in recent weeks offer some blueprints for targeted measures aimed at addressing payment difficulties of firms as demand for products and services or supply of inputs has suddenly dried up. Options include extended deadlines for tax and mortgage payments, cheap loans extended via development banks, public guarantees or short-work schemes to tide firms over a difficult period. Limited fiscal room for maneuver in some Eurozone countries such as Greece and Italy – even assuming that EU fiscal rules are likely to be temporarily suspended - could revive debt sustainability concerns. Hence a European fiscal response is warranted to move additional resources.
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