Covid-19 outbreak poses risk to euro area forecast
With more than 280 confirmed cases of Covid-19 at time of writing, Italy has become the third worst-hit country in the world, after China and South Korea. The fact that the virus has hurt Italy’s industrial heartland (Lombardy alone accounts for 22% of total Italian GDP) is of particular concern.
We had been pencilling in some sort of modest rebound in the Italian economy at the start of this year, driven by household spending, but the disappointing Q4 GDP figure combined with the recent virus outbreak clearly means our 0.4% GDP growth forecast for Italy this year is at risk. After Q4 growth of -0.3%, the probability of a recession (i.e. two quarters of negative growth) has sharply increased. We will revisit our forecasts in the coming days, taking into account the Q4 19 GDP details (to be published on March 4) and incoming information about the virus.
The Italian government has already pushed through some fiscal stimulus to the most affected areas (see above) and is contemplating additional measures to provide liquidity to small and medium-sized businesses. Italy may also ask the EU for some budget flexibility for 2020.
The virus outbreak in Italy has sharply increased the downside risks to our overall euro area growth outlook. Our base case is that the virus is a transitory shock and that a V-shaped recovery is the most probable scenario provided the outbreak is contained and does not spread to other European countries. But any further rise in the economic cost could cause us to shift our view. Monetary policy could be back in the spotlight. The European Central Bank (ECB) is already close to the limit of what it can do, but if pushed can probably be counted upon to consider new rate cuts, another round of quantitative easting etc...
What recent surveys have revealed is that the coronavirus is a supply, not a demand, shock, meaning a rate cut would not help that much. What is needed are special measures to alleviate the pressure on businesses impacted most by the disruption and the maintenance of supportive financial conditions. Altering the composition of the ECB’s asset-purchase programme to include more corporate bond purchases could be a way forward. Targeted fiscal measures could also form part of the solution.
Short term, we do not expect the ECB to take any policy action in March.
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