Lowering our forecast for the euro area
Two weeks ago, we were working on the assumption that there would be no major outbreak outside China. But since then the covid-19 virus has spread rapidly to Europe.
Furthermore, the resumption of economic activity in China is still looking much slower than we had expected despite signs the virus was being brought under control by the authorities there. Therefore, the hit to European exports to Asia as well as supply-chain disruptions may be more severe than we had previously thought.
With the short-term slowdown likely to be more pronounced than we had previously anticipated, we now expect growth in the euro area to be close to zero in H1 2020, and consecutive quarters of negative growth in some countries, before we see a rebound in Q3. As a result, , we have cut our annual growth forecast for the euro area to 0.5% from the 1.0% we projected in November last year.
The uncertainty attached to our projections is significant. The main unknown is how individuals and businesses react to the increasing anxiety surrounding the epidemic. A lot will also depend on whether there are other major outbreaks in Europe, as well as how long they last and the policy responses from central banks and governments.
The risk now is that the virus weakens the fundamentals of domestic demand. We remain particularly concerned about the potential damage to household and corporate income.
It is not easy to say how European policymakers should respond to the covid-19 shock. Several countries have already adopted or are preparing measures to mitigate the impact of the coronavirus, especially Italy. But we will probably see higher public spending in other countries as well, including Germany.
Monetary policy (or at least monetary policy alone) may be less effective for dealing with the current situation. This might explain why the European Central Bank has been more reluctant to act than other central banks. But this does not mean that the ECB can simply stand idle. It has already said it stands ready to take “appropriate and targeted measures”. We expect a special longer-term repo operation (LTRO) to be announced next week. Further rate cuts or an increase in the ECB’s monthly asset purchases programme cannot be excluded.
Read full report here