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13.03.2020 19

ECB meeting: now, fiscal policy has to play its part

Published March 13, 2020

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The essential

  • ECB action: At its meeting on 12 March, the ECB disappointed market expectations by not cutting rates in the wake of the coronavirus spread. The bank delivered additional unconventional monetary easing thorough a temporary boost to its QE programme, which will see a set of additional net asset purchases worth EUR 120Bn this year. Such purchases will be mainly skewed towards the private sector. In addition, the ECB will temporarily be conducting additional LTROs to provide immediate support to the Eurozone financial system while the ECB’s banking supervision will provide temporary capital and operational relief in reaction to the coronavirus outbreak. Finally, the ECB supports the EBA decision to postpone the 2020 stress test so that banks can focus on business. Importantly, Ms Lagarde made a strongly worded request for “ambitious and coordinated fiscal policy”, as the response to the coronavirus-induced crisis should be fiscal first and foremost. Indeed, European countries are announcing significant stimulus plans that should buy time while the epidemic is being contained. Once the epidemic has been contained, measures to stimulate aggregate demand would be needed to ensure a significant growth rebound.
  • Investment implications: Central banks’ recent actions have failed to support the markets, which have recorded heavily losses. Also, the Fed decision to pump additional liquidity into the system failed to drive a rebound. While it is too early to call the bottom, a trigger is needed which we think would need to be a massive and coordinated fiscal reaction, along with drastic virus containment measures. Until something concrete materialises, market volatility will continue to be very high. However, at least, CB action should avoid a credit crunch, but pressure on spread products is likely to remain. We expect an increasing divergence between the valuation of issuers with solid balance sheets and other, weaker issuers. The enhanced QE programme is supportive of euro IG credit in the overall credit space. However, it is still too early for an aggressive move into risky assets.
  • Beyond the short term: The initial supply shock related to the epidemic is giving rise to a demand shock of increasing magnitude and the global economy could plunge into a recession as severe as that experienced in 2008-09. However, macroeconomic stabilisation measures are reasonable simple to design and are not the sole responsibility of monetary policy. Governments have become aware of the seriousness of the situation and, in exceptional circumstances, the Stability and Growth Pact provides for a temporary relaxation of budgetary rules. However, for fiscal policy to be truly effective, it has to be accompanied by persistently accommodative monetary policy. Ultimately, the countries in crisis will emerge with higher stocks of public debt and the ECB balance sheet should grow significantly. For countries to remain solvent, interest rates will have to remain low.


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