>> GROUP: Shadow ECB Council / EZB-Schattenrat  Dr. Sylvain Broyer

Dr. Sylvain Broyer: The short-term outlook for the Eurozone economy has deteriorated with the coronavirus outbreak now expected to shave 50 basis points (bps) off growth in 2020. The main transmission channels are the exports of goods and services (especially tourism), possible disruption of supply chains and a delay in the expected manufacturing restocking cycle. A contraction of 1Q GDP is now possible. Italy, hardest hit so far, is forecast to see the largest reduction in growth of 0.7% in Q1, saar.

A negative demand shock is materializing, and could weaken consumption in the first half. Several big sporting, commercial and cultural events scheduled for March/April have been cancelled and some authorities are prohibiting any large gatherings. About 19% of European consumer expenditures is on recreation and culture, restaurant, and hotels. Transportation (16% of expenditures) has only been restricted so far for countries hit by the COVID-19 virus but is at risk. Tourism could be a transmission channel, as 72% of EU tourism expenditures are spent by EU citizens. The countries the most dependent on tourism are Spain (11% of GDP), Portugal (9%), France (7%), Italy (6%), Austria (6%), and Greece (5%).

Last week was the worst for European equities since the European debt crisis and the VDAX reached its highest level since October 2011. However, long-terms yields are only marginally higher and monetary conditions (the mix of real exchange rate and money markets rates) have not tightened. Importantly, the Eurozone remains an economy mostly financed by banks. 32% of households’ financial wealth being in form of currency and deposits, wealth effects on consumption derived from equity prices are not large and mostly relevant to the UK economy.

On policy, we forecast a 10bps cut in the ECB policy rate in response to the markets’ sell-off and lower projections. There is no reason for it to wait for its regular meeting. Even if the bar has been high before the markets’ sell-off, a rate cut would make sense in two respects:
1. as credit easing measure, since banks would have higher incentives to grant loans via TLTROs. The ECB could think about introducing further incentives for banks to grant loans for SME’s facing liquidity issues
2. to stem the unwinding of carry trades funded in euro, which act as destabilizing forces on global financial markets, what would bring the appreciation of the euro to an end.
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