Central Banks

ECB set for policy decision as coronavirus sends the euro zone economy into a tailspin

Key Points
  • The euro zone economy is in a tailspin.
  • Business activity surveys for April came in at record lows last week.
  • The German Ifo Index never been lower.
Deflation risks might be on the rise, strategist says

The European Central Bank's (ECB) Governing Council will convene in a virtual meeting Thursday to discuss whether the measures taken, for now, are enough to weather what could be the worst economic crisis since World War II. 

The odds are high that ECB President Christine Lagarde will stress the central bank's ability to do more if needed in order to avoid fragmentation in the euro area and a tightening of financial conditions. 

"There are two objectives the ECB will focus on at that stage. First, to ensure accommodative financial conditions and preventing tensions in the financial system," said Dirk Schumacher, an ECB watcher with Natixis, in a research note. 

"Second to create fiscal space for governments to fight the cyclical consequences of the pandemic." 

To manage the second objective, the ECB is trying to rein in spread expansions between the core and so-called peripheral countries such as Italy, Spain, Portugal and Greece. A spread refers to the difference in the yields between countries, which can highlight how fearful investors have become on owning European debt.  

The new 750 billion euro ($815 billion) Pandemic Emergency Purchase Programme (PEPP) has a lot more flexibility than the bank's "normal" Asset Purchase Program, according to a legal opinion which was published March 24 in the official journal of the EU. 

ECB may be forced to support economy more during coronavirus slowdown: ANZ Bank

"Surely the ECB would have hoped to be safe for much longer after launching its PEPP bazooka on March 18, but the reality is that the economic and political situation remains highly challenging with the central bank still perceived as the only credible bulwark against an unwarranted tightening of financial conditions," said Frederik Ducrozet of Pictet Wealth Management in a note. 

The euro zone economy is in a tailspin. Business activity surveys for April came in at record lows last week, the German Ifo Index never been lower, and many economists predict the economy is going through its worst recession since the 1930s. 

"It will be an opportunity to take stock, as the first hard data for Q1 (the first quarter) start coming in, painting a clearer picture of the initial damage to the economy," said Anatoli Annenkov with Societe Generale in a note to clients. 

"Unless there is another bond market scare we would expect the ECB to remain on hold for now while fine-tuning collateral and supervisory rules to support credit flows." 

The ECB's April lending survey shows that credit standards for loans to enterprises and households have tightened in the first quarter, while demand for loans and drawing of credit lines have surged. 

"At the very least, the ECB will be under pressure to signal the possibility of an increase in the 750 billion euro envelop sooner rather than later," said Ducrozet. 

Whether the PEPP will be big enough is already being questioned by some economists. For now the ECB is expected to hold steady and analyze the current measures.

EU pandemic response will likely come from ECB before governments: economist