MacroscopeAs 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

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A television broadcast showing Christine Lagarde, president of the European Central Bank, is pictured during a trading session at Frankfurt’s stock exchange on March 12. Photo: Reuters

Published: 10:00pm, 16 Mar 2020Updated: 11:17pm, 16 Mar 2020

It doesn’t take much to expose the flaws in the euro zone economy but the coronavirus epidemic has already ripped asunder any hope of getting back to sounder growth for a long time. Europe is clearly heading into recession as the pandemic takes a heavy toll on consumer demand, business activity and financial market confidence.

We are heading into uncharted territory with the national lockdowns in Italy and Spain foreshadowing bigger trouble ahead for Europe’s largest economies, Germany and France, with plenty of negative spillover likely for the rest of the region. Just how deep the recession descends depends upon how effectively Europe’s policymakers respond. Judging by the official response so far, it’s no surprise markets are panicking.

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.