European leaders are being shaken out of their complacency. With news that coronavirus infections have been identified in every EU country, the economic outlook is worsening as fast as the disease is spreading. The Bank of England’s emergency stimulus on Wednesday, as well as actions taken by EU governments, put the onus on the European Central Bank to do its part.
Radical policies are being rolled out across the EU. Quarantine measures now apply to the whole of Italy. Spain, which has seen the sharpest acceleration of infections in recent days, has closed one chamber of its parliament and banned direct flights from Italy. Austria is imposing border controls.
These disruptions, along with the effect on confidence from the intensifying siege mentality, are rapidly causing economic damage. The eurozone economy was already suffering a slowdown. This motivated the ECB’s easing package in September last year, which helped arrest if not reverse the industrial recession. But any stabilisation has now been undermined by the Covid-19 crisis. Some observers suggest that the eurozone could see its sharpest economic contraction since the global financial crisis.
EU member states are stepping up. Welcome measures to support businesses if they temporarily reduce working hours, or to postpone tax payments, have been put in place in France, Germany and elsewhere. But to be fully effective, national measures must be complemented by action at the EU and eurozone level.
The European Council was right on Tuesday to call for flexible application of financial rules. Brussels should now suspend fiscal constraints, as the rule book permits in emergencies beyond governments’ control. More funding for businesses and governments can be mobilised through European official lenders and the EU budget: a common public good such as health is what joint spending is for.
But the most effective action needs to come from the ECB, which meets on Thursday. Unless it acts forcefully, it risks falling further behind the curve. Despite US president Donald Trump’s castigation of the “slow-moving” Federal Reserve, the US central bank has already taken dramatic action, delivering a large emergency rate cut last week. The euro has since risen relative to the dollar, adding disinflationary pressure to the eurozone economy. This is reinforced by the plunge in oil prices.
The Bank of England’s package is particularly impressive. Beyond a large rate cut, a new targeted liquidity facility gives banks incentives to sustain business lending, and bank capital requirements have been eased. The most helpful thing the ECB can do is to emulate the BoE’s actions to ensure credit is easily available to offset any tightening in businesses’ cash flows.
Like the BoE, the ECB can design a refinancing operation to give banks generous incentives to lend to exposed businesses. It can even go further than Threadneedle Street in boosting asset purchases, in particular for corporate bonds. The ECB should also endorse regulatory forbearance and fiscal guarantees for credit to affected businesses.
While the ECB’s already-negative deposit rate makes it hard to match the Fed and the BoE’s rate cuts, it should at the very least not disappoint market expectations: futures pricing implies a 0.1 percentage point cut to the deposit rate now, with more to come in the spring. This would ease overall financial conditions and support demand.
EU bodies have a history of waiting too long to act in economic crises. The ECB acquitted itself well in September. It would be tragic if the first big decision on president Christine Lagarde’s watch was a return to bad habits.
