Vulcan Insight

Europe’s Economic response to Coronavirus steps up a gear

13 March 2020

On Thursday the European Central Bank announced a monetary policy stimulus package in an attempt to shield the eurozone from the economic damage caused by the Coronavirus.  As countries and regions close borders and impose travel restrictions on their citizens, economists are predicting the eurozone is about the suffer its most serious economic shock since the 2008 financial crisis.

The disruption caused by coronavirus will hit both the demand and the supply side of the economy, as quarantined consumers are unable to spend and factories are forced to slow production, as well as impacting consumer and investor sentiment. In the bank’s first monetary stimulus since Christine Lagarde became President in November, Frankfurt announced large and temporary increase of their Quantitative Easing programme, while keeping rates unchanged at minus 0.5%. The bank also announced that it would amp up its existing programme of cheap loans for banks, known as targeted long-term refinancing operations, in order to provide immediate support to the eurozone financial system and assist small businesses hit by the disruption.

Economists have given European Central Bank’s decision mixed reviews, with some investors disappointed that the main bank rate remains unchanged. Commercial banks are complaining that their profits are being squeezed by the €11 billion of annual negative interest rates. In a rare swipe at the bank, French President Emmanuel Macron called the response insufficient, while Italian Prime Minister Giuseppe Conte said the role of the ECB is “not hindering but facilitating” and that the institution should create “favourable financial conditions”. Jens Weidmann, head of the German Bundesbank and member of the ECB governing council, defended the bank’s actions saying that “we reacted appropriately to our role and opportunities”.

The performance of the ECB President at the press conference on Thursday raised eyebrows as Ms. Lagarde announced in the midst of the Italian bond selloff that it was not the role of the institution to close spreads. The announcement was immediately met by a bond-market sell-off, with Italian sovereign bond prices fell by a record amount, increasing concern about Italian sovereign risk. This appeared to contrast with her predecessor Mario Draghi’s assertion in 2012 that the ECB was prepared to do “whatever it takes” to preserve the euro. Christine Lagarde later clarified her comments in an interview, saying that she is “fully committed to avoid any fragmentation in a difficult moment for the euro area”.

The move by the European institution comes as the Bank of England cut the main bank rate to 0.25% on Wednesday and launched a package of targeted measures, including incentivizing banks to lend more. This was combined with the announcement of a budget that will radically increase public borrowing, bringing ten years of austerity economics imposed by the Conservative Party to a dramatic end.  Across the pond, the U.S. Federal Reserve also cut rates 0.5%, as the global economy prepared for the unprecedented effects of Covid-19.