How to keep the economy going
* The spread of Covid-19 represents a serious threat to the global economy. The shock to demand, output and supply chains is likely to be significant. The stampede by investors out of equities and into the ‘safe haven’ of government bonds and gold in the last fortnight testifies to the growing nervousness. Policymakers want to ensure that the inevitable hit to economic activity is shallow and short-lived. To do so they will need to prevent a hit to growth turning into a liquidity crisis, in which businesses, banks and households run out of cash.
* With inflation at low levels and the risks to growth mounting, the incentives for policymakers are to move aggressively and with wide-ranging measures. Policy is likely to become more experimental. The weapons in this crisis, like those deployed in the financial crisis, will be a mix of the general and the targeted, the latter reflecting the differing effects across sectors and by size and type of firm. The financial crisis demonstrated that for maximum effect the policy response should be coordinated across finance ministries and central banks.
* Global monetary policy is shifting to ease. China’s central bank was the first to cut interest rates, but others, including those in Indonesia, Canada and Australia have followed suit. The US Federal Reserve demonstrated its determination to support growth with a 0.5-percentage-point rate cut which took place outside the normal meeting schedule – an action that was last seen in the financial crisis. Markets are assuming the US will cut further and that the UK will follow.
* In the euro area, where interest rates are already negative, the value of further rate cuts is more debatable. The European Central Bank could respond by expanding its programme of quantitative easing to bolster asset prices, drive down market interest rates and increase liquidity. Doubts about the effectiveness of rate cuts from current, low levels, means that other countries may both cut rates and undertake quantitative easing.
* Lower interest rates and asset purchases do not guarantee an increased flow of bank credit to businesses and consumers. This requires a more targeted approach. China’s central bank has offered cheap credit to banks contingent on their lending it on to the private sector. During the financial crisis a number of countries used similar measures and these, too, may be revived. Controls on bank lending and balance sheets, so-called macro prudential policy, could be eased to encourage more lending.
* The financial crisis demonstrated that cash was king. Today the hit to salaries and corporate revenues from Covid-19 threatens a cash crunch. This is where monetary and fiscal policy need to work together.
* Last week the incoming governor of the Bank of England, Andrew Bailey, said that the authorities would probably have to provide bridging finance to assist small businesses. In 2008 the UK cut VAT rates temporarily to help corporate cash flow and the Fed encouraged banks to restructure loans for borrowers facing temporary liquidity problems. In this week’s UK budget the chancellor could offer to delay tax bills for distressed firms or introduce schemes to support bank lending. Last week the government extended statutory sick pay so it is now available from the first, rather than the fourth day, for those who are ‘self-isolating’. Further support for those unable to work as a result of the Covid-19 could be seen in the budget.
* Yet no amount of liquidity and cash will fully counter the impact of consumers staying at home, workplaces staying closed and firms cancelling spending plans. This is an area where fiscal policy can play a role. Healthcare spending is surging across the world and many governments are using fiscal policy to deliver a wider boost. China has increased funding for regions affected by the virus and made targeted tax cuts. The US House of Representatives last week authorised emergency support for small businesses. South Korea is offering tax breaks and rent subsidies to prop up household incomes. Hong Kong’s government is giving each adult permanent resident just under $1,300 in cash and is cutting payroll taxes for 2m workers.
* An apparently insatiable market appetite for government debt, and the resulting ultra-low borrowing costs, mean that governments will have no problems financing extra spending. Despite a doubling of UK government debt relative to GDP since 2007, borrowing costs have sunk to all-time lows. Interest payments on the stock of government debt are, by historical standards, low relative to total spending. In today’s exceptional circumstances the chancellor might reasonably choose to suspend, or soften, the fiscal rules which limit debt-funded spending in Wednesday’s budget. This would provide the headroom for more spending on public services, salaries, support for industry, benefits and tax cuts.
* None of the many measures described above can prevent Covid-19 from hitting growth. Significant disruption is happening and more is inevitable. The OECD has cut its global GDP growth forecast for 2020 from 3.0% in November to 2.4% in response to the crisis. In a more severe scenario growth would fall to just 1.5%. UK growth is forecast at 0.8% this year, down from 1.3% in 2019, and would be lower in the OECD’s more severe scenario.
* The question is whether the authorities act on a scale sufficient to prevent the first-round hit to growth developing into a wider, and more protracted, financial and credit crunch. That could spell a more severe downturn. We see three positive signs.
* First, the scale of the threat is creating a consensus for an aggressive response. Bailing out banks and pumping up asset prices in response to the financial crisis was controversial; keeping lending going and supporting peoples’ incomes during an epidemic is much less so. The risks in terms of human health and of the economy of doing too little are far greater than the risks of doing too much. Voters are unlikely to treat politicians and policymakers who get this wrong indulgently. The incentives for policymakers are to throw everything at this. As the UK chancellor, Rishi Sunak, said yesterday, the response to the virus will be “at scale”.
* Second, contrary to what is sometimes said, policymakers have not ‘run out of bullets’. Governments could borrow to spend on an enormous scale. Interest rates are low, but, as the euro crisis demonstrated, central banks have plenty of other tools at their disposal to boost lending, liquidity and confidence. Deployed imaginatively and in coordination, fiscal and monetary policy remain powerful. The experience of countering the global financial crisis, and the resulting institutional and regulatory architecture, mean we are better placed to navigate today’s challenges.
* Third, economies, especially advanced ones, tend to be resilient and adaptable. The evidence from earlier epidemics and from natural disasters and terrorist attacks is that after the initial shock activity comes back. In time people and organisations find their way round problems. The last 12 years have given businesses and government considerable experience in managing volatility and uncertainty. A decade of tight regulation and debt reduction have, according to the Bank of England, put UK banks in a good position to manage economic shocks. UK corporates are also running significantly lower levels of debt as a share of GDP than in 2007 and, collectively, cash holdings are at record levels.
* Agreed, it’s not hard to spot areas of vulnerability. Debt levels have risen sharply in some areas of the corporate sector. Many households would struggle to manage a few weeks’ interruption to earnings. The leisure, travel and hospitality sectors are in the eye of this storm. Small firms are generally frailer than larger ones with varied operations and big balance sheets.
* The policy response will need to identify such risks, and forestall them. It will be a tricky balance maintaining the liquidity of sound businesses without supporting the unviable. The authorities won’t get it right every time. But this crisis will be solved, as happened in the financial crisis, by the public sector taking more of the strain as private-sector activity is disrupted. That is likely to mean more government borrowing and an expansion of central bank balance sheets.
* We’re in for a temporary bout of volatility and weaker activity. But the policy response is coming, and it is likely to be big. That provides the best way of stopping a health emergency turning into an economic crisis.
OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 1.8% at 6,463 as concerns grew over the economic disruption caused by Covid-19.
Economics and business
* Global cases of Covid-19 rose to over 109,000 and deaths to over 3,800. New daily cases in China continued to fall. Total cases exceed 7,300 in South Korea and Italy, and 6,500 in Iran
* The Fed cut interest rates by 50 basis points, its first cut outside its regularly scheduled meetings since 2008. Central banks in Australia, Canada and Malaysia also cut rates
* Markets are pricing in a 25 basis points cut by the Bank of England this month, as well as additional cuts by the Fed and the European Central Bank
* Global equity markets were volatile last week, while yields on US 10-year government bonds fell below 1% to record lows
* The OECD cut its 2020 global GDP growth forecast from 2.9% to 2.4%, assuming that Covid-19 outbreaks outside China are contained. In the case of a broad global outbreak, the OECD expects global GDP growth to slow to 1.5%
* Dutch bank ING expects GDP to contract by 1.2% in Japan and by 0.3% in Italy in 2020, and growth of 0.5% in the UK and Germany
* Crude oil prices fell sharply on Friday to $46/b, the lowest level since 2017, after OPEC members and Russia failed to agree on a new round of production cuts to stabilise prices
* The IMF pledged $50bn and the World Bank $12bn to help developing countries manage Covid-19 outbreaks
* The US House of Representatives passed an $8.3bn stimulus package to fund health agencies and state and local governments to fight Covid-19 and to support vaccine development
* The FT reported that the UK budget to be announced this week will include measures to support companies facing cash flow problems owing to the disruption caused by Covid-19
* Italy more than doubled its planned fiscal stimulus to €7.4bn to support families and businesses affected by the economic impact of Covid-19
* Italy closed all schools until mid-March and restricted movement on the northern region of Lombardy and neighbouring provinces
* The International Air Transport Association (IATA) estimates that airlines may lose $113bn in 2020 owing to Covid-19, similar to the impact of the global financial crisis
* Passenger car sales fell by 80% year on year in February in China, the world’s largest car market
* Purchasing manager indices fell to a record low in China and Hong Kong in February
* The US added more jobs than expected as wages rose and unemployment fell to a 50-year low. Any disruption related to Covid-19 would be unlikely to show in this data, which covers February
* Household spending unexpectedly contracted in Japan in January, the latest in a string of disappointing data for the economy
* The UK and EU formally commenced negotiations on their future relationship
* Following last week’s talks, the EU’s chief negotiator cautioned: “There are many divergences, very serious divergences"
* A UK-US trade deal would add 0.16% to GDP according to new UK government estimates
* The Office for Budget Responsibility found that proposed UK immigration rules would lead to a slower population growth and hence lower growth and reduced tax revenues
* UK regional airline Flybe entered administration
* UK department store John Lewis cut its staff bonus to a 67-year low
* Nissan unveiled a new metal press at its Sunderland plant, part of an ongoing £400m investment in the UK
* The escalation in conflict in Syria led Turkish president Recep Tayyip Erdogan to ask for greater European support
* Turkey, currently sheltering 4.1m refugees, encouraged refugees to head to the Greek border where they were met with violence by Greek border guards
* A ceasefire was agreed between Turkey and Russia but the situation remains volatile
* Joe Biden had a strong showing in the ‘Super Tuesday’ round of US Democratic primaries, clearly overtaking Bernie Sanders as the bookmaker’s favourite
* Pete Buttigieg, Michael Bloomberg, Elizabeth Warren and Amy Klobuchar suspended their campaigns
And finally... Deloitte are not the only ones to be celebrating their 175th anniversary this year. In honour of reaching their dodransbicentennial, Scientific American reprinted a story from 1866 last week. Reportedly, during the construction of Westminster Bridge the use of diving bells was abandoned in favour of diving suits as the labourers were found to be spending their time at the bottom playing cards. They noted “It is not easy to play cards in a diving dress [suit] alone, however, and the remedy has proved very satisfactory in its operations.” – Rummy behaviour