Fra Moodys:
What Can Governments Do to Contain the Outbreak?
The week ahead brings several economic datapoints for Europe, but markets won’t care about them. With the euro zone economy on the brink of collapse, what matters now is how fast the COVID-19 spreads across the Continent and to what extent governments manage to contain the outbreak.
Financial markets are in meltdown, with almost all stock indexes having entered a bear market on Thursday. There could be some rebound in the short term, but we expect that the bloodbath will carry into next week, especially if cases and deaths in other European countries spike at the same rate as they did in Italy. We estimate that several European countries are around two weeks behind Italy with regard to the spread of the virus, meaning that coming weeks will remain chaotic.
Cases and deaths are surging in Germany, France and Spain, while there is currently no European country without recorded infections. To avoid shutting down an entire economy—which is what is happening to Italy right now—some governments have announced forceful containment measures in recent days. School and university closures became the norm, but some countries also have banned public events, limited travel, closed gyms, saunas and other establishments, and reduced opening hours for restaurants and cafes.
Slovakia, the Czech Republic and Hungary have even declared states of emergency. There is now little doubt that consumer spending across the euro zone will be hit hard by the virus, with services spending suffering the most. Granted, some offset will come from households stockpiling on primary necessity goods such as food and medicine, but such a boost won’t be enough to counterbalance the dent to discretionary spending.
This chaotic situation is putting business under increased financial pressure, with the focus on small and medium-size enterprises in the retail, hospitality and leisure sectors. On the upside, the European Central Bank and other central banks in Europe have loosened monetary conditions over the past week.
The ECB, for instance, put in place liquidity operations aimed at providing cheaper and more available loans for SMEs, while at the same time it increased its quantitative easing programme and focused it on purchases of private bonds. The Bank of England did the same, launching a Term Funding Scheme with special incentives for SMEs on Wednesday.
But there is only so much that monetary policy can do. This is why the focus next week will be on the response of euro zone governments to the crisis. As of now, not much has been done. Italy, the hardest hit country, has announced a €25 billion fiscal package to support the economy, but other governments left much to be desired. ECB President Christine Lagarde insisted several times during the ECB press conference that immediate and coordinated fiscal action is needed, but this only raised fears that, as of now, there has been no consensus among euro zone governments.
Germany is in the spotlight—the country has substantial space to loosen policy and increase spending, but its politicians are known for being extremely averse to stimulus measures. Our view is that some fiscal stimulus in the euro zone will come, but maybe not as quickly as needed.
Elsewhere outside the euro zone, the U.K. led by example, announcing a coronavirus package worth £12 billion on Thursday, with unlimited resources promised to its health system. The outlook for the euro zone is grim. Consumer spending is expected to fall off a cliff in most euro zone economies in March and April, with risks tilted to the downside, since disruptions could be extended until May or June if the virus isn’t contained.
Investment is also expected to plunge, because no one will dare to push through big ticket decisions given the state of affairs. Exports are also expected to decline, as demand from other countries is similarly being depressed. Only government spending is likely to support the economy in coming months. We still don’t have a euro zone recession in our
baseline, but such a scenario is now looking the most likely. Italy’s GDP is already certain to contract sharply in the three months to March, with odds that other countries will follow suit.
The numbers for the second quarter should also be horrendous, though forecasting now is extremely hard given the high levels of uncertainty. We continue to expect the economy will rebound in the third quarter—assuming the virus is contained by summer—with the announced monetary stimulus and the expected fiscal loosening creating upside risks for growth in the second half of the year. But too much could go wrong in the meantime, so we are updating our assessments on a daily basis.
