“Fiscal, first and foremost”

Extra time required in the euro area

The key chart

The ECB revised down its outlook for growth and called for “an ambitious and collective fiscal response” (December 2019 forecasts (o); March 2020 forecasts (n))
Source: ECB; CMMP analysis

A crucial week – part 2

On Thursday 12 March 2020, the President of the ECB, Christine Lagarde made a clear call for a policy reboot in the euro area. Unsurprisingly, Madame Lagarde presented a downbeat assessment for economic activity in the region. GDP forecasts were revised down to 0.8% (from 1.1%) for 2020 and to 1.3% (from 1.4%) for 2021 and left unchanged at 1.4%. Inflation forecasts were unchanged at 1.1% for 2020, 1.4% for 2021 and 1.6% for 2022 although downside risks were acknowledged notably from lower oil prices. (These new forecasts do not reflect the potential impact of the Coronavirus fully, due to their timing.)

Prior to the meeting, expectations had included a -0.1% cut in the deposit facility rate to -0.6%, a lending facility and a boost to QE (FT, 2020). The ECB did not deliver on the former. Instead, they announced a package of measures including a further €120bn of bond purchases and more cheap loans for banks. But, and more importantly, the key message was extremely clear – Madame Lagarde highlighted that the appropriate and required response to the current growth shock “should be fiscal, first and foremost.” In the Q&A session, she also noted that the fiscal measures already announced totalled only €27bn ie, a quarter of 1% of the GDP for the EA…adding:

“…hence, we are calling for an ambitious and collective fiscal response.”

Christine Lagarde, President of the ECB. 12 March 2020
The UK delivered in the first half
The UK delivered in the first half – a sustained fiscal loosening combined and coordinated with a package of Bank of England measures (OBR forecasts for public sector deficit as % GDP)
Source: OBR; CMMP analysis

This was a crucial week for policy makers in Europe. The UK delivered with the “largest sustained fiscal loosening since the pre-election budget of March 1992” combined with a coordinated package of measures from the Bank of England.

“Mais, en attendant…”
To repeat – does it make sense to run tight fiscal policy (1) at this point in the cycle and in the face of weakening global growth and (2) when the private sector is running persistent financial surpluses? (4Q sum of financial balances, % GDP)
Source: ECB; Haver; CMMP analysis

As feared, the European response has been more limited and insufficient. Madame Lagarde was correct in her assessment of the required response, but the second half of this crucial week ends ultimately in disappointment. Extra time is required…

Please note that the summary comments above are extracts from more detailed analysis that is available separately

chris@cmmacroperspectives.com