Staring down the abyss of a prolonged global recession, political leaders from across the world are lining up an array of tax breaks, financial support for companies and fiscal stimulus measures to shore up their struggling economies.

On the monetary-policy side, major central banks like the US Fed and the Bank of England have cut their benchmark interest rates by half a percentage point each recently to prevent the coronavirus outbreak from dealing a massive blow to their economies and financial systems.

But with eurozone interest rates alread at a historically low zero percent, or even in negative territory as far as the deposit rate is concerned, the European Central Bank (ECB) had only a few options left in its armory.

As ECB President Christine Lagarde faces the biggest test of her leadership just four months into the job, most economists are urging her to continue the “whatever it takes” policy of her predecessor Mario Draghi, who is widely credited for saving the euro with ultraloose monetary policy during the 2010 eurozone sovereign debt crisis.

Close-up picture of ECB President Christine Lagarde

In a conference call with eurozone political leaders on March 10, ECB President Christine Lagarde raised a scenario ‘that will remind many of us of the 2008 Great Financial Crisis’ unless they act urgently

Provide ample liquidity

Thursday’s policy decisions include additional Longer-Term Refinancing Operations (LTROs) — measures that are intended to provide supercheap funding and liquidity for commercial banks to prevent credit markets from drying up like in the wake of the 2008 collapse of US investment bank Lehman Brothers.

“Although the Governing Council does not see material signs of strains in money markets or liquidity shortages in the banking system, these operations will provide an effective backstop in case of need,” the ECB said in a statement

Moreover, the ECB in June of this year will be easing the terms of its Targeted Long-Term Refinancing Operations (TLTRO’s) which offer banks loans at potentially negative interest rates, meaning it actually pays banks to borrow money if they lend the cash on to companies and households. The rates to be paid for such loans will be 25 percentage points lower than the ECB’s deposit rate of currently minus 0.5%, and the terms for collateral to be handed in by commercial lenders will also be eased.

That move is intended to encourage lending to small and medium-sized enterprises should they see cash flows dry up as the virus disrupts supply chains, travel and spending.

Punish money hoarders

Meanwhile, the central banks’ headline instrument, cutting rates, is virtually exhausted for the ECB. This is why the bank has stopped short of driving its deposit rate, currently at minus 0.5%, deeper into negative territory for money parked with the ECB.

Commercial banks are already complaining that negative interest rates are proving an increasing burden on their profitability. And a refinancing rate at a historically low zero percent doesn’t help either because there’s simply not enough demand for cheap credit in most eurozone countries.

All eurozone interest rates would remain at the current levels, the central bank said, until policymakers “have seen the inflation outlook robustly converge” to the ECB’s state goal of just below 2%.

In a move widely expected by financial markets, the ECB decided to raise the bank’s asset purchases by an additional €120 billion ($135 billion) until the end of this year. Currently it is buying assets at a rate of €20 billion per month. Thereby, it’s planning to focus more on bonds issued by companies, with the aim of lowering borrowing costs for the private sector even further.

However, the program, known as quantitative easing (QE), is hugely controversial across the euro area. The total of more than €2.6 trillion of purchases already done by the ECB has come under political and legal attack and has sowed deep divisions among eurozone members about whose assets are bought and why.

Double whammy of supply and demand shocks

But despite Lagarde’s bold promise that the shock will be temporary if the right steps were taken, many analysts believe that the challenges facing the coronavirus-hit econmies around the world will be different and much more complex this time.

Holger Schmieding, chief economist at Berenberg Bank, for example, says the world is facing “a medical emergency that monetary and fiscal policy cannot fix.” Monetary stimulus could spur demand for goods, he told the news agency Reuters, but the global health crisis is also dealing a blow to the supply side of economies.

As businesses close and people stay at home, highlighted by Italy’s dramatic decision this week to close shops and limit travel across the country, lower interest rates and tax cuts won’t help.

This is why Christine Lagarde already said in mid-February that “monetary policy cannot, and should not, be the only game in town” to stimulate economies.

Governments ready for stimulus

And indeed, there is a growing realization among eurozone governments that the ECB’s demand-boosting monetary measures may not be the most effective response in a crisis stoked by a shock to supply. Even Germany, which was so far reluctant to give up its “black zero” budget mantra is softening its long-standing opposition to increasing spending.

Chancellor Angela Merkel’s cabinet agreed at the weekend to make it easier for companies to put workers on shortened hours — a government-funded program that is credited with limiting job losses in the wake of the 2009 financial crisis and helping speed up the economic recovery afterward.

Moreover, Berlin is also considering tax relief for companies if their sales fall suddenly, and even discussed a package of measures including €3.1 billion in extra investment spending per year from 2021 to 2024.

At the EU level, the European Commission has announced it will earmark €25 billion within the EU budget to fund emergency measures, and said it would be more flexible in EU rules limiting national debt.

The measure will especially help Italy, the EU country hardest hit by the virus outbreak. Rome this week announced budget-busting measures to the tune of €25 billion in support of health services, and to ensure that people do not lose jobs due to restrictions.

Despite the monetary and fiscal support, a recession in the eurozone “looks unavoidable,” economists from the British bank HSBC said in an analysis this week, and concluded: “It’s hard to be optimistic…the European economy faces an extremely difficult few months ahead.”

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