It is now commonly known that the coronavirus dealt a significant blow to growth outlook and blindsided global central banks just when markets thought that things were looking up and the manufacturing recession was dying out.
Data from the first two months of the year was encouraging as it reflected the sentiment before infections started to rise substantially in Europe. This was seen in the PMI indicator and the IFO survey, while the European Commission's economic sentiment indicator also improved, rising to 103.5 from 102.6 in January, a better than expected level.
Before the outbreak, good news seemed to be emerging, with the inventory correction in the manufacturing sector largely over, setting the stage for a recovery. That said, Covid-19 is now clearly jeopardising a further gradual acceleration in growth. In addition things now also look a bit worse in the services sector, which was up till now the stronghold of the economy preventing a more severe slowdown.
Leisure, tourism and transport will inevitably suffer from a more fearful consumer. To top that off, the fact that Italy decided to close schools and universities until mid-March might be wise from a precautionary point of view, but is at the same time exacerbating the negative growth impact.
At the moment, it is difficult to make an estimate as to how profound the Covid-19 epidemic will be and how long it will last. That said, if we look at the Chinese experience, there is some hope that the peak will be reached in the second quarter, although there is no guarantee this will happen. Should the latter happen, this would mean that the supply disruptions and drop in demand are likely to affect both the first and second quarters. Thereafter, markets should expect a temporary acceleration in growth, however GDP growth should still be impaired.
As expected, inflation fell from 1.4 per cent to 1.2 per cent in February as lower energy prices started to push the headline figure down. Core inflation inched up from 1.1 per cent to 1.2 per cent, probably stoked by some Covid-19 induced supply disruptions. Even though markets saw better business confidence figures in February, selling price expectations actually fell in all sectors except industry, a sign that inflationary pressures are still largely absent. Hence, inflation might face renewed downward pressure in the wake of the economic slowdown.
Politicians are likely to take some measures to contain the negative impact of Covid-19. We have already seen the Italian government proposing a tax credit for companies experiencing a 25 per cent fall in revenues. At the same time, there will be strong pressure on the European Central Bank, especially given the surprise Federal Reserve rate cut.
The feel by market participants at this juncture is more of a fiscal pact rather than a monetary issue, given that the latter’s effective is fading away. That said, if there is internationally-coordinated action from central banks to counter a tightening of financing conditions, we could still see the ECB cut rates a bit further, and increase the amount of asset purchases.
However, it is clear that the ECB will try to avoid this scenario and in a first instance work on other levers. As such, the Bank is more likely to support the banking system by increasing the size of the negative rate exempt tier of excess liquidity holdings. For sure, what looks certain is that any thoughts of monetary tightening can now be shelved for a prolonged period.
This article was issued by Maria Fenech, credit analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.