Over to you, Christine. After the Federal Reserve delivered an emergency half-a-percentage-point cut in interest rates on Tuesday, pressure is rising on the European Central Bank to respond with easing measures of its own.
Ms Lagarde has promised a more consensual style of leadership at the ECB than that of her predecessor, Mario Draghi. Now, just four months into her tenure, the economic threat of coronavirus poses the first big challenge ahead of next Thursday’s policy meeting.
At the moment, government bond investors do not appear to be expecting the kind of kitchen-sink response favoured by Mr Draghi. Germany’s 10-year bond yield — which serves as a benchmark for the eurozone — has fallen 0.2 percentage points in the week and a half since the spread of the virus outside China began to dominate market action, to trade at minus 0.63 per cent on Wednesday. That is not much, compared with a 0.5 percentage point plunge in 10-year US Treasury yields over the same period.
In part, this reflects the ECB’s lack of room for manoeuvre. Euro-area interest rates are at a record low of minus 0.5 per cent, while debate rages over the negative side effects of life below zero. But that, combined with Ms Lagarde’s pledge to seek a broad consensus, means traders are pricing in just 0.1 percentage points of cuts next week.
“You can’t help feeling this would look different if Draghi was still in charge,” said Rabobank strategist Lyn Graham-Taylor. “I think we’d be talking about another big package of rate cuts, QE, and other measures. Markets are pricing in some institutional inertia at the ECB.”
Rate cuts are not the only tool available. ECB policymakers are reportedly considering a further round of cheap loans to banks, targeted at those that fund small and medium-sized businesses. And some investors expect the ECB to beef up its €20bn a month bond-buying programme, with Pimco saying on Wednesday that the central bank “will likely increase the pace of its asset purchases”.
Looking at eurozone markets, the big beneficiaries of the Fed cut have been Italy and Greece. Both countries’ bonds sold off sharply during the early part of the coronavirus scare but have recouped much of their losses this week, suggesting the hunt for yield is not dead.
The performance of Germany’s bonds also reflects the possibility that Berlin may be drawing up a spending package to counter the impact of coronavirus, thinks Mr Graham-Taylor. Finance minister Olaf Scholz has raised the possibility of suspending Germany’s “debt brake”, which limits its ability to run budget deficits.
Since taking over, Ms Lagarde has argued that governments — particularly those getting paid to borrow — need to do their bit when it comes to stimulating the economy, rather than leaving it all to the ECB. The virus could yet help to spark the spending spree she has been hoping for.
