As the coronavirus takes its toll, here’s what the European Central Bank must do to save the euro zone economy
- The ECB missed an opportunity to walk in step with the US and Britain and cut interest rates last week
- In addition to pumping liquidity into the market, the bank must shore up high-risk bond markets and ban speculative short-selling
Europe’s bond and credit markets are definitely showing the strain. It’s not so much that Germany’s yield curve has turned negative on safe-haven and flight-to-quality flows, but that bond spreads for riskier markets have started to surge.
The bellwether 10-year spread of Italian government bonds over equivalent German yields has exploded out to 2.34 per cent in recent days as investors have fled for cover. Talk about Italy’s “doom loop” has resurfaced again, with deepening recession risk, the fragility of the Italian banking sector and the potential threat of future credit default combining to put the wind up the markets. It hasn’t helped that the European Central Bank seems to be turning its back on the bond market’s plight.
In a shocking display of official insouciance last week, ECB president Christine Lagarde suggested it was not the central bank’s job to close down bond spreads for highly indebted euro zone countries.
The coronavirus crisis is such an unprecedented event it’s hard to say how bad the downturn could be in the coming months. At the worst point of the global financial crash, European growth sank as low as -5.7 per cent in the first quarter of 2009, but was less extreme during the 2010-2013 European debt crisis with a -1.2 per cent low-point for growth in early-2013.
Europe can do it again, but it needs to follow a series of bold steps. Firstly, the ECB needs to release a new flood of cheaper money, cutting interest rates again, while stepping up more quantitative easing with extra term lending injections into the markets.
Thirdly, the ECB must initiate direct intervention in support of high-risk bond markets like Italy.
Fourthly, it needs to ban speculative short-selling, which exploits the coronavirus crisis. These are exceptional times requiring special preventive measures.
Europe’s policymakers can rise above the crisis. But it needs to build bridges with the rest of the world, especially the US and China, working together to end the mayhem. It’s not just down to finding a cure for Covid-19, but limiting the economic damage which follows.
David Brown is chief executive of New View Economics