Weekly Update - Covid-19 – The Policy Response

According to our economists’ latest projections, the euro zone economy should see a fall of -0.7% in its GDP this year.

If the pandemic comes under control by June as is currently expected, the second half of 2020 should see a return to more normal levels of activity, accelerating into 2021 when our economists expect growth to reach 1.2%. The speed and scale of recovery is dependent on three main factors – a successful public health policy of containment, properly functioning financial and interbank markets and, finally, government support for businesses, artisans and households. In terms of the public health response, the World Health Organisation is calling for testing for Covid-19 to be ramped up. Further, many medical researchers have concluded that the quicker shutdowns are in place, the quicker the spread of infection can be slowed. This suggests that many countries may have to push through more draconian measures, meaning that the economic impact is likely to grow further. The response from central banks has been unprecedented in its scale and speed. Yesterday alone saw rate cuts in Taiwan, Indonesia, South Africa and the United Kingdom – the Bank of England cut rates by 15 basis points to 0.1%, the lowest level in its 326-year history. The BoE also boosted its asset purchase programme by £200bn to £645bn. Late on Wednesday evening, the European Central bank held an extraordinary meeting and decided to create a new asset purchase plan totalling €750bn, to be deployed until at least the end of 2020. This comes in addition to the ECB’s existing programmes (which should total around €320bn for the remainder of this year), meaning a 40% increase in its total holdings. The US Federal Reserve has also been active this week, launching a support programme for the commercial paper market (short-term corporate borrowing instruments totalling $1tn) to ensure continued access to liquidity for companies. The Fed also relaunched its Money Market Mutual Fund Liquidity Facility, last used during the 2007-2009 crisis, to ensure that funds would be able to meet requests for cash. And yesterday, the Fed opened swap lines with nine more central banks (including Brazil, South Korea and Australia), to ensure ready access to cheap dollars across the globe. This comes in reaction to signs of a dollar shortage for global businesses, which had pushed the greenback up 15.7% year-to-date against an index of emerging currencies by this Wednesday. Since the Fed acted, the dollar has eased lower by around 1%. Central bank policy is deployed to keep the financial and interbank markets functioning. However, it will do little to help businesses and households in the short term. This is where government policy comes in. In recent days, a dizzying series of announcements from authorities has unfolded. Massive programmes of loan guarantees for businesses and direct support for companies and families have been introduced. In the euro zone, these amount to some 8.5% of GDP while London’s support packages could reach 15% of the UK economy. In the US, the Republican party yesterday unveiled a $1tn fiscal stimulus plan (around 5% of GDP) which includes $1,200 payments to adults and $500 for every child to help with meeting essential needs.

Bottom line. The combined effect of the stimulus on offer has enabled markets to stabilise since mid-week, with global equities rising yesterday while government bond yields fell. However, the expected increase in new Covid-19 cases is likely to spark new restrictions and shutdowns on economies. Although this in turn is likely to be met with further easing measures by central banks and governments, markets are likely to remain volatile and a very defensive stance remains advisable.

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