March 13, 2020–This week, the Bank of England (BOE) and the European Central Bank (ECB) both announced stimulus measures aimed at responding to the growing impact of COVID-19. The BOE cut interest rates by 50 basis points, while the ECB left rates unchanged, though both institutions also announced broad-ranging stimulus packages designed to alleviate the impact of the spreading virus on both the real economy and the financial markets. Shares sold off sharply on Thursday, with the Euro Stoxx falling 12% on the day as the ECB measures disappointed markets; amid declining liquidity, the New York Federal Reserve stepped in with a large package of repo-market operations and Treasury purchases.
Can interest rate cuts do much in the face of a viral outbreak? Not especially, and their purpose is more about sending a confidence-inspiring message of support, hence the decision of a number of central banks to deliver such emergency cuts. The ECB was constrained by the presence of a bloc within the Governing Council who are sceptical of the efficacy of deeply negative rates. The ECB instead announced a corporate-focused addition to their Asset Purchase Program, as well as an expansion of their Targeted Longer-Term Refinancing Operation with incentives to boost lending to small- and medium-sized enterprises. This latter scheme has now also been launched by the BOE as a means of assuaging the liquidity impact on the most impacted firms.
Several governments in Europe began restricting movements and gatherings of their citizens this week, with Italy, Denmark, and Ireland at the forefront. Given that the COVID-19 case count in countries, including France and Spain, is closely following the trajectory seen in Italy (with a lag), such measures seem inevitable across Europe.
This outbreak could scarcely have come at a worse time for both the UK and the Eurozone economies, with fourth quarter 2019 growth of 0.0% and 0.1%, respectively. The United Kingdom was coming out of a period of heightened uncertainty due to the protracted Brexit negotiations, with tentative signs of a bounce to come, while the Eurozone was buffeted by the trade war because of its high export dependency. Therefore, it is clear fiscal policy will have a major role to play in the response to this emergency, given the constraints facing monetary policy. While an expansionary budgetary policy has been anticipated in the United Kingdom since the Conservative’s election victory, the £30 billion package devoted to tackling COVID-19 was a meaningful measure, representing 1.3% of GDP and delivered in coordination with the BOE. Italy received sign-off from the European Commission to deliver a similarly sized package, and it seems likely that all-comers will be allowed to sidestep the Commission-imposed budgetary restrictions if necessary. Even Germany looks set to treat this as a severe enough emergency to deviate from its balanced-budget commitment, with Chancellor Angela Merkel vowing to do whatever is necessary.
While uncertainty reigns and we may not yet have seen the bottom in risk markets, rebalancing is not about calling a bottom. Rather, it is about keeping the portfolio’s exposure to equity risk consistent over time.
Tom O’Mahony, Investment Director, Capital Markets Research