The monetary stimulus package from the European Central Bank (ECB) is essential to survive the worst recession of the post-war period, according to Close Brother Asset Management’s Robert Alster.
As that recession looms over the eurozone, there is disunity emerging between the ECB and its larger member states, as the pandemic emergency purchase programme (PEPP) was met by efforts from Germany’s Constitutional Court to curb its powers.
Late last week, the decision was made to extend the ECB’s emergency bond purchase scheme to June 2021, increasing it by €600bn to €1.35tn. In September, this figure is expected to rise to €1.85tn.
Ulrike Kastens, economist at DWS, outlined that the ECB remains steadfast and is only subject to the jurisprudence of the European Court of Justice, rather than individual, national courts.
“It further marks a significant step towards greater transparency, which could actually be rather helpful in boosting the effectiveness of monetary policy,” she noted.
Alster, head of investment services at Close Brothers Asset Management, noted that the original ECB stimulus package would aid economic recovery but “the €750bn package is unlikely to be the silver bullet."
Markets rallied as a result of the enlarged stimulus and showed positive effects on bond yields, giving a much-needed boost to nations such as Italy and Spain, casualties of the hit to tourism and hospitality.
Through a combination of fiscal and monetary intervention, there has been a substantial credit growth in all major eurozone countries. Measures from the ECB and loan guarantees granted by the states have helped smaller companies obtain much needed liquidity. Which, in turn, helps these companies survive the crisis and prevent job losses in the region.
Furthermore, amidst growing concerns that the disparity between northern and southern Europe could grow following the crisis, Italian yields fell by 14 basis points. Crucially, the gap between Italian and German bonds, a key benchmark, narrowed by 16 basis points.
European corporate credit growth, year-on-year change
Source: Haver Analytics
Projections showed inflation is at just 0.3 per cent in 2020 versus 1.1 per cent expected in March, and a worryingly low inflation forecast for 2022 at 1.3 per cent. Recent figures have shown deflation in 12 of the 19 countries using the euro and growth is seen for under the ECB’s baseline scenario, at -8.7 per cent.
European Central Bank president Christine Lagarde expects a rebound in Q3 and the projections indicate growth bouncing back to 5.2 per cent in 2021.
An advocate of the increased stimulus package, Close Brothers’ Alster feels the recovery could have an even more worrying impact than a low inflation level.
“Considering the ongoing effects of Covid-19, this low level is hardly surprising,” Alster noted. “Although, it’s hard to see any inflation at all. Everything is deflation. Inflation is the last thing to worry about at this point.”
In the face of deflationary pressure, there seems little alternative to sustaining stimulus. A prolonged period of deflation is worrying for the eurozone as corporate and government debt levels would be even harder to manage as interest payments stay fixed, but wages, prices and tax payments all fall.
Alster outlined that preventing deflation has its answer in inspiring confidence in consumers to start spending again.
“It’s worth noting that in recent years, European policymakers have struggled to deliver inflation, but, amid the pandemic and the associated EU-wide slump in consumer spending, their job today is exponentially harder,” he said.
Euro area inflation rate July 2019 to May 2020
Source: Trading Economics
This is in line with Lagarde’s warnings that weaker demand will exert a longer-lasting pressure on inflation.
“On the ground, weak day-to-day consumer spending is exacerbated by limited transactions for key ‘big ticket’ items such as cars and holidays,” Alster continued.
Stimulating this confidence is key, but rising unemployment, conflicting and disparate lockdowns and a further sense of uncertainty suggest that it may be sometime time before demand can meet the required levels.
The general sentiment is that the easing of lockdowns will see a tentative approach to spending.
In the UK businesses are slowly reopening. An Office for National Statistics (ONS) survey found that 81 per cent of companies were operating in May, up from 75 per cent in late March and early April. Some 24 per cent of businesses that had suspended trading were planning to resume operations before mid-June.
“As lockdown eases, there will be a mix, in certain areas where there is pent up demand,” Alster said. “However, there will be other areas where people are fearful, or will take longer to adjust while there is still not a vaccine."
“There are two cohorts of people underlying this, those below the age of 40 who are fit and those above the age of 40 who are fearful. This will drive a large part of demand.”
For those in the second bracket, they will remember the period of 1981/2, which saw the peak of inflation and the beginnings of globalisation. Is there a case to be made that in the age of re-examining supply chains, globalisation is now in reverse? The once single minded financial aims of corporations now encompass more environmental and socio-political factors.
The growth of outsourcing reduced the cost of labour and production, driving down prices. However, Alster is keen to point out European nations found themselves in a precarious position because of this.
“We can’t be in the position again where Asia has a pandemic and all our factories grind to a halt in days,” he said.