Snapshot

Economics

ECB fine tunes its support for banks as GDP collapses

The European Central Bank’s (ECB) governing council decided to keep its key interest rates unchanged, and did not alter its various quantitative easing programmes. Some investors were hoping that the ECB would raise the size of the pandemic emergency purchase programme (PEPP) that was announced in March, but they were left disappointed.

European equities fell further on the day while Italian bond yields drifted higher (prices fell) following the announcement.

While the ECB left its main policy tools unchanged, it did reduce the interest rate on its latest targeted long-term refinancing operations (TLTROs III) by 0.25 percentage points, taking them below the ECB’s deposit rate for banks that can show an improvement in lending.

This means that a bank that had recently increased lending, or reduced the fall in its loans, can borrow large sums from the ECB, only to put the money on deposit at the central bank and make a profit – known as a carry trade.

This should encourage a sharp rise in the take up of new loans from the ECB, but does it help the real economy or is this just financial trickery designed to boost confidence? Naturally, we are sceptical over the usefulness of the measure, except for banks of course.

GDP data shows sharp contraction

Earlier in the day, the first set of post-crisis GDP figures were released. The flash estimate for first quarter eurozone GDP showed the economy contracted by 3.8% quarter-on-quarter (q/q), worse than consensus estimates, and biggest decline in activity since the formation of the euro in 1999. A handful of other member states also published their preliminary estimates.

  • France’s GDP growth was -5.8% q/q and -5.4% year-on-year (y/y)
  • Spain’s GDP growth was -5.2% q/q and -4.1% y/y
  • Italy’s GDP growth was -4.7% q/q and -4.8% y/y

All of the publishing statistical agencies noted sharp falls in both domestic demand and international trade. Only France published a full expenditure breakdown but as these are preliminary estimates, there is a greater than usual degree of uncertainty attached to them.

The initial GDP estimates allow us to think about the scale of the economic impact from the Covid-19 shutdowns. As we know when each country went into lockdown in the first quarter, we can estimate what share of the economy was impacted. By our estimates, 32-34% of the French economy was shut down, while for Spain, the estimate stands at 30-32%. These are roughly inline with the estimates that were produced by INSEE (France’s agency).

Italian data is a little more puzzling. Given that Italy went into national lockdown approximately a week before France and Spain, with the Lombardy region even earlier, it makes little sense for its GDP growth to have contracted less than the other two. The difference in terms of sector shares is not large enough to make a difference, and when we run our estimate of the share of Italy’s economy impacted, we get an implausible answer of 17-19%. Given Italy enforced one of the most stringent lockdowns, we question the quality of the data published.

The Italian statistics agency ISTAT does warn of potentially large revisions. This makes sense as early estimates for GDP typically have little or no information about the third month in a quarter. They are also are prone to ‘survival bias’ in that non-respondents are ignored in surveys, whereas this time, they could be not responding due to shutdown or insolvency (creating an upward bias). 

Finally, the other important signal from the GDP figures is that Germany appears to have fared much better than those that have reported so far. This could be because lockdowns there were introduced later, and the German government has been more successful in minimising cases and deaths.

As we look forward to the second quarter, although economic data still has further to fall before we reach a bottom, the speed and success of lifting lockdowns will be critical in setting the pace of recoveries.

Monetary and fiscal policy will continue to play vital roles in minimising company failures and the rise in unemployment. So far, policies appear to be sufficient for most economies, but there will be some countries like Italy where the legacy costs from Covid-19 may be too much. See: Are Italy’s days in the eurozone numbered?