Global central bank view: Further stimulus expected from all major central banks – Downside risks to the economic outlook have intensified over the last week, given the spread of the corona virus around the world. We are currently in the process of downgrading our global economic scenario and will announce detailed changes tomorrow. However, given recent developments, we now expect an imminent easing of monetary policy by central banks – potentially in a coordinated fashion. Some commentators have argued that what we are witnessing is a supply shock and therefore central bank action is pointless. We disagree. The shock has always been of both demand and supply in nature, and if anything, we think we are now predominantly witnessing a demand shock. This reflects the tightening of financial conditions, changes in the behavior of households in terms of consumer spending and travel and the sharp tightening of financial conditions we have seen over recent days. Add to that a likely hit to business and consumer confidence, and the demand effects are likely to overwhelm the fall back in production. In addition, most economies went into this shock growing at sub-trend rates and with below-target inflation. Rate cuts will not cure a virus, but they can help cushion the economic fall-out. This takes nothing away from the view that fiscal measures would be highly desirable and really should be taking more of the lead. Indeed, we expect a stepping up of fiscal stimulus in the coming months.
ECB easing package in March – We recently shifted our expectation for a fresh round of monetary stimulus from March to June. This reflected signals from ECB officials that they were not yet ready to make a decision on the implications of the corona virus shock for the economic outlook. However, given the tightening of financial conditions, it now looks likely that ECB stimulus will come sooner rather than later. Today’s comments form officials suggested a readiness to act before long. ECB Vice President de Guindos said the ECB remained ‘vigilant and will closely monitor all incoming data’ and that it ‘stands ready to adjust all its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner’. We now expect a stimulus package to be announced in March. It is a very close call, but we think the March meeting is somewhat more likely than at April’s meeting. We continue to expect the ECB to cut its deposit rate by 10bp, step up net asset purchases to EUR 40bn and further loosen conditions on the TLTRO programme. We will review the possibility of further moves in line with the upcoming change to our economic scenario.
Fed to cut by 50bp in March; potentially more later – Following the highly unusual statement issued by Chair Powell late on Friday, markets have moved rapidly to fully price in a 50bp cut for the 17-18 March FOMC meeting. Given the very fragile stabilisation in equity markets we are seeing today, we expect the Fed to follow through and meet these market expectations by cutting 50bp at the March FOMC, to put a floor under the rapid deterioration in market sentiment (previously, we expected a 25bp cut in Q2). In the US, the financial market-real economy linkage is much stronger than in other parts of the world, which explains the speed of the Fed’s response. How and when the Fed responds exactly will therefore depend in part on how financial conditions evolve from here. Should we see renewed falls in equity markets, the Fed may opt to cut rates before the scheduled FOMC meeting – perhaps in coordination with other central banks, to maximise the impact. From there, further easing will depend on how quickly the real economy weakens, both on the back of government measures/behavioural changes to contain the spread of the virus itself, as well as the financial conditions channel – for instance, whether consumer confidence falls in response to the equity market declines, as has often happened in the past. We will explore these possibilities further when we publish our revised growth forecasts tomorrow.
Continued frontloading of monetary and fiscal stimulus in China – To offset the fall-out from the severe disturbances to the economy stemming from the corona crisis, the authorities have already taken numerous steps. They have frontloaded piecemeal monetary and fiscal easing measures, as well as targeted support for certain sectors and companies. Over the past weeks, the PBoC has continued with mini cuts of several policy interest rates. The central bank also announced it would lower banks’ reserve requirements further: after reducing bank RRRs by 400 bps in 2018 and 2019 and by 50 bps (to 12.5%) in January 2020. We expect another 150 bp RRR cuts during the course of this year. On the fiscal front, the authorities had already frontloaded and raised the local government bond quota for the issuance of special bonds to finance infrastructure projects; in January this fed into a sharp rise into new lending. The government has also announced special tax breaks as well as targeted state support for sectors most hit by the corona crisis, such as the airline industry. Meanwhile, macroprudential regulation is also being relaxed, as financial sector supervisors have for instance allowed banks to delay the recognition of bad loans extended to SMEs suffering from the corona crisis. We expect the Chinese authorities to continue with the frontloading of fiscal and monetary easing measures, while relaxing macroprudential measures to stem the headwinds created by the corona crisis.
BoJ: Balance sheet expansion more likely than a rate cut – The Japanese economy was already in a fragile state following the consumption tax hike last October, and given the country is among those most affected by the coronavirus outbreak, the Bank of Japan has also issued an emergency statement attempting to calm financial markets. The next BoJ meeting comes just a day after the March FOMC meeting, on 19 March, and here too we expect an easing of monetary policy. However, the policy response is not as clear-cut as for other central banks, given the proximity of rates to the effective lower bound, and that negative rates have been perceived to have a negative impact on bank profitability and therefore the broader financial system in Japan. Given this, further easing is more likely to involve use of the balance sheet rather than interest rate cuts. An increased pace of JGB purchases looks inevitable, but a clue for what else could be on the table came with a record purchase of ETFs today. The ETF market remains relatively small in Japan, but the market has proven itself to be responsive to BoJ policy, and so any increase in the pace of purchases will likely be met with adequate new supply. As a base case, we expect the BoJ to raise the annual targets for ETF purchases, while for JGBs, we expect it to signal that it will increase the pace of purchases to meet the existing monetary base target (currently, the pace of purchases is running well below the target).
BoE: 25bp cut for now; fiscal policy to play a bigger role – The Bank of England already looked close to cutting rates in recent meetings, but we had expected policy to stay on hold given the rapid rebound in confidence following the general election, and the prospect of significant fiscal stimulus being announced with the 11 March Budget. The coronavirus fallout makes a bigger fiscal package even more likely, but we now expect this to be supplemented by a 25bp cut at the 26 March MPC meeting. This move is already fully priced by financial markets, and so as with the Fed, the action will be more about stabilising sentiment rather than providing stimulus. Further out, and depending on precisely how the UK economy is affected, a further rate cut and a step up of asset purchases is also possible.
What is priced in? The market has already priced in a lot of stimulus from the ECB. Indeed, one 10bp rate cut is priced in fully by the April meeting and a second rate cut is partly priced in for 2020. In addition, we judge that a step up of QE is priced in if we compare current levels of the term premium to those seen in August of last year. The market had priced in a QE package of EUR 40-50 bn a month, in August 2019. Ultimately, the ECB disappointed the market with a package of only EUR 20bn a month. From August until January, the term premia increased by about 45bps at the longer-end of the curve. Currently, the 30-year term premia is more or less at the same level as in August, whereas the term premia is a bit lower for shorter-maturities. Consequently, we judge that a step-up in net monthly asset purchases by EUR20-30bn to EUR 40-50bn has been more or less priced in based on our estimates of the fall in the term premium over recent weeks. (Nick Kounis, Bill Diviney, Aline Schuiling, Arjen van Dijkhuizen, Jolien van den Ende, Floortje Merten)