As euro zone recession deepens, ECB to scale up bond buying next month
19 May, 2020, 6:00 am
The euro zone economy’s worst recession on record will be even deeper than forecast less than a month ago, according to a Reuters poll of economists who said the European Central Bank will ramp up its bond-buying again next month.
An economic recovery from the coronavirus pandemic, which has killed nearly 300,000 people globally, will largely depend on the effectiveness of individual governments in preventing a second wave of infections despite easings of lockdown restrictions.
“The biggest uncertainty now is around the pace of the reopening of the economy. There is a series of risks that are still to the downside…We may have a more prolonged period of confinement measures imposed by law or just behaviourally,” Giada Giani, European economist at Citi, said.
Fears about that risk meant a broad measure of European stocks was set to end the week 3% lower – the biggest weekly fall since the mid-March rout in global shares – while euro zone government bond yields have tumbled.
The May 11-14 Reuters poll of nearly 80 economists marks the third downgrade to the economic outlook in a little over a month, despite the ECB adding hundreds of billions of euros to its balance sheet and governments announcing stimulus worth trillions of euros.
The euro zone economy is expected to contract 7.5% in 2020, more than the 5.4% predicted three weeks ago, with the worst of the blow expected this quarter.
After contracting 3.8% in January-March, its sharpest quarter-on-quarter decline since 1995, the economy was shown in the latest poll shrinking by 11.3% in April-June, more than the 9.6% predicted last month.
The economy is not expected to make up for that in the second half of this year or next, growing 7.2% and 2.8% in the third and final quarters of 2020, respectively.
But the worst-case scenario has the economy contracting in Q3 as well as Q2, while stagnating in Q4, showing powerful downside risks to forecasts.
Indeed, the euro zone’s biggest economy, Germany, has sunk into a deep recession after the steepest quarterly contraction since the 2009 financial crisis at the start of the year, official preliminary data showed on Friday.
Despite the substantial fall in GDP, the unemployment rate is expected to rise only about two percentage points to 9.3% in 2020 from recent lows of 7.4%. That compares with forecasts of a much sharper rise in unemployment in the United States.
“While the lion’s share of this year’s U.S. fiscal stimulus is geared toward smoothing household income through labour market dislocations, European governments have provided firms with wage guarantees and expanded short-time work incentives to reduce labour market dislocations,” economists at JP Morgan said.
That does not include the 20 billion euros per month of purchases already announced in response to a slowdown that had taken hold well before the coronavirus hit Europe. The poll forecast the ECB’s balance sheet, currently at around 5 trillion euros, would expand to 6.5 trillion euros by year-end.
“Monetary policy will be almost maxed out before this recession ends,” Citi’s Giani said.
“At the moment, it has the objective of making the usage of fiscal policy easier. The ECB can do this by increasing the size of purchases and extending it beyond this year.”
More than two-thirds of 28 economists said the ECB was likely to follow the U.S. Federal Reserve’s example by adding to its shopping list corporate bonds that have lost investment grade status during the crisis, referred to by some as “fallen angels”.
“By buying fallen angels, the ECB can limit the fall-out of the pandemic,” Spyros Andreopoulos, senior European economist at BNP Paribas, said.
“It is a way to reach a broader segment of corporates – a segment that may increase in size now that the ECB recognises the impact of the pandemic will stretch into the medium-term.”
But this could expose the ECB to even more criticism when it is already dealing with a German Constitutional Court ruling that the central bank would have to prove its bond-buying programme was necessary and proportional.
Over 75% of respondents who answered an additional question – 22 of 29 – said that ruling would not have a long-term impact on the way the ECB sets policy.