“Go big” is the message from the UK, as the country delivers co-ordinated fiscal and monetary easing to combat the economic shock of the coronavirus outbreak.
The Bank of England and Treasury delivered a one-two punch on Wednesday. First, Mark Carney, the BoE governor, announced a half a percentage point cut to the UK interest rate. Then, Rishi Sunak, the UK chancellor, launched a £30bn stimulus package in his first Budget.
The joint action is a model both for Europe and for the US, with financial markets badly in need of a circuit breaker that can provide relief after weeks of volatile trading.
Equity markets’ reaction to the London measures suggested ambivalence, with indices turning negative during the UK trading day. Some observers questioned the effectiveness of cutting interest rates towards zero. In Europe, plenty have argued that current negative overnight rates are counterproductive — particularly for banks.
But credit and tax measures that help businesses weather the likely cash-flow shock from a deepening health crisis are essential, as outlined by both Mr Carney and Mr Sunak. Meanwhile, fiscal spending is necessary to moderate the pain for economies that are largely dependent on the service sector.
The UK approach may prove to be a “template” for the US, said Seema Shah, chief strategist at Principal Global Investors. “A gap may be about to open up between US and European market performance, reflecting the lack of policy action from the US government and straightforward interest rate cuts from the Federal Reserve, just as Europe, and especially the UK, is starting to aggressively ramp up their stimulus plans.”
The turmoil in financial markets and sharp declines in equities reflect anxiety that a recession is looming, with Covid-19 set to deliver a nasty supply and demand shock. Weaker global demand from Europe and North America will also challenge China’s nascent recovery.
In broad terms, global equities have endured a drop in the region of one-fifth, a slide that distinguished the growth scares seen in late-2018, from 2015 into early 2016, and during 2011. Fortunately the global economy avoided a recession on each of those occasions. This time, the jury is still out.
Getting ahead of a larger downturn, without crushing consumer and business confidence, is the primary task for governments — particularly when central banks have depleted monetary arsenals. It is unclear if this will prevent a deeper economic contraction but, in the case of the UK, the partnership of fiscal and monetary policy is something worth applauding.
Silvia Dall’Angelo, senior economist at Federated Hermes, said the BoE’s timing was better than the Federal Reserve’s last week, as it “points to co-ordination across different UK policymakers at a time of extraordinary uncertainty”.
This approach should be quickly emulated by Europe and the US, where those pushing comprehensive spending measures have to negotiate election-year dynamics. The European Central Bank is set to announce new stimulus measures on Thursday, but there is far less optimism over regional governments’ fiscal rules being loosened.
ECB head Christine Lagarde warned EU leaders during a conference call late on Tuesday that the lack of a co-ordinated policy response “will see a scenario that will remind many of us of 2008 great financial crisis”.
Other countries such as Australia, Canada and South Korea are set to roll out new spending initiatives but, clearly, Europe and the US must take the lead.
During the BoE press conference, Mark Carney was asked whether the economic fallout from the coronavirus outbreak could prove as damaging as the 2008 global financial crisis. The governor responded that “there is no reason for this shock to turn into the equivalent of 2008 . . . if we handle it well”.
That is the crux of the matter for investors. They would “soon be faced with a fuller picture of how the first round of a ‘co-ordinated’ response has developed,” said Ian Lyngen at BMO Capital Markets. “Even if the fiscal side proves somewhat late to the party as it were, greater clarity is surely in the offing.”
The question is what investors see, once they have that clearer view.
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