Chief Economist’s Weekly Brief – Epicentre

Countries put on lockdown, rates slashed, stock markets savaged, trillions poured into the US financial system and an historical Budget in the UK. Last week was shocking as it was breathless. There’s been a sizeable dose of policy stimulus to combat the growing economic fallout of the coronavirus outbreak and the threats to financial stability. There will likely need to be a whole lot more.   

First up. The UK’s policy response began in earnest on Wednesday. The Bank of England cut Bank Rate by 50pbs to 0.25%, back to its lowest rate on record. Additionally, the calls for more targeted measures than just a rate cut (a fairly blunt instrument in the current climate) were heeded with the announcement of a new term funding scheme with additional incentives for small and medium-sized enterprises. Banks will also see their requirements to hold capital buffers loosened.

Second dose. The baton was passed to the Chancellor and his Budget. Proceedings were kicked off with a £12bn package, on top an existing giveaway of £18bn, to cushion the economic fallout. It means the economy is getting a boost to the tune of 1.3% of GDP in the coming financial year. Measures included providing more resources to the NHS, enhancements made to statutory sick pay (SSP) for workers and rate relief and refunds of SSP for businesses. It is too early to gauge the magnitude of the downturn in the economy. But this should help limit the downside risks.

Not enough The ECB announced various measures to support the fragile euro area economy. A more generous loan program for banks was unveiled. This was clearly aimed at supporting vulnerable SMEs. A new liquidity operation was also unveiled, whilst capital and liquidity buffers for banks were eased albeit temporarily. QE was expanded by Eur120bn up to year-end, but there was no official rate cut. Despite all of this, the markets did not feel reassured that the ECB will do “whatever it takes” to support Eurozone’s vulnerable members, especially Italy. After the announcements last Thursday, the pan-European Stoxx 600 index had its worst-ever day, plunging 11.5%.

Fiscal bazookas. With limited monetary ammunition, the onus is on European governments to step up to the plate and deliver a sizeable fiscal boost. The European commission promised a €37bn fund to handle the economic consequences of the outbreak. Eurozone finance ministers will meet on Monday to discuss coordinated response. France called for a “European stimulus package” to be announced by the EU leaders’ summit at the end of this month.  Meanwhile individual countries start announcing fiscal support for their economies. Germany pledged unlimited cash to businesses hit by the coronavirus and signalled readiness to reverse the balanced budget rule. Italy promised  €25bn of extra spending to protect its economy. But now would be a good time for coordinated response and risk sharing.

Kitchen sink. Last week the Fed was forced to respond to growing threats to global financial conditions, intervening to support the market for US government debt amidst signs of “highly unusual disruptions”. Yesterday came the kitchen sink with rates slashed by 100bps effectively to zero, having only just cut rate by 50bps earlier this month. Its quantitative easing programme was restarted ($700bn in purchases) and a host of other measures were announced to help ease strains in bank funding and avoid any squeeze on credit.

Millennial in Number 11. Such was the week that the most decisive change in the role of government spending in the economy seen for a generation was almost confined to a footnote. Aside from the short-term stimulus the government is ramping up departmental spending and investment (more information in last week’s Budget briefing). In the coming years the economy is set to experience the biggest sustained fiscal loosening since the pre-election Budget of March 1992. This is going to help pump up GDP in medium term, all other things equal, perhaps by as much as 1%.

Standstill. The UK economy started the year in a precarious position, registering absolutely no growth in January 2020. Nil. Nada. Nothing. On a rolling three-monthly basis, output has now flat-lined for the past three months straight. The service sector stagnated over the three months to January, with weakness particularly evident in telecoms and in retail sales, while manufacturing output declined yet again. Only the construction industry, where renewed housebuilding activity led to 1.4% growth, prevented an outright contraction. And this is before all the Covid-19 woes.

Who dunnit? In the decade since 2008, UK labour productivity growth has averaged just 0.3% per annum – the weakest since the 1890s. What caused this productivity puzzle? Bank forbearance, weak management practices, mismeasurement and the decline of the highly productive oil & gas industry have been cited. Uncertainty from rapid technological change causing firms to delay investment is another, alongside firms plugging pension deficits instead of investing. Productivity has been singled out as the culprit behind the UK’s poor economic growth performance. But looking for the culprit behind the poor productivity performance is like Agatha Christie’s Murder on the Orient Express – everyone has had a hand in it.

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