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World faces huge bill for 'flattening the curve' - making solidarity among EU nations crucial

Pearse Conaty


Crisis: ECB’s Christine Lagarde

Crisis: ECB’s Christine Lagarde

Crisis: ECB’s Christine Lagarde

AS consumers and businesses across Ireland emerge from the lockdown, we know there will be a huge financial price to pay for flattening the curve.

Covid-19 struck at a time when Europe was already growing below trend, inflation was below target, debt ratios were high in many countries and interest rates were negative. The room for a policy response was limited in the event of an adverse shock.

How European politicians and the European Central Bank (ECB) respond to Covid-19 will lay the groundwork for what type of recovery we will see and what could derail it. This impacts every citizen and business for the next decade.

The IMF predicts Irish and eurozone GDP will contract by 6.8pc and 7.5pc respectively in 2020 and grow by 6.3pc and 4.7pc in 2021. Global growth is forecast to fall 3pc in 2020 and rebound by 5.8pc in 2021.

In 2009, global growth fell by just 0.1pc, putting the current forecast in sobering context.

The strength of recoveries will depend on medical advances on testing, treatment and vaccines. The positive news is that fiscal and monetary policymakers have acted swiftly in launching the biggest policy stimulus in history.

The US Federal Reserve bought $1 trillion of Treasuries in four weeks, more than any of their previous QE programmes combined. Actions that were unthinkable in January are now daily events.

Europe's response has been less cohesive. The ECB has launched a QE programme totalling €1 trillion for 2020. Governments have launched a variety of fiscal measures.

Prior crises show that governments which provide sufficient stimulus for their economies healed faster.

It is notable that stronger economies in Europe, such as Germany, have announced stimulus equivalent to 10pc of GDP, while weaker and harder- hit economies such as Spain and Italy have announced more modest stimulus, around 2pc of GDP, in part because borrowing is more costly.

This raises the possibility that growth rates will keep diverging within the eurozone, a problem for many years.

ECB president Christine Lagarde has called for a common European fiscal response that is "swift, sizeable and symmetrical".

The economy commissioner, Paolo Gentiloni, said: "Not having a level playing field is dangerous."

Old wounds around common debt issuance - anathema to the northern core of Austria, Germany and the Netherlands - have resurfaced.

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Common debt to pay for coronavirus fallout raises the spectre of moral hazard whereby it would cost more for the northern core and less for the periphery. This leaves the Dutch feeling punished for their financial prudence relative to, say, the Italians.

This came to a head at the recent Economic and Financial Affairs Council at which the Portuguese publicly rebuked the Netherlands' hard-line finance minister.

While the Dutch may have a point in normal times, it is hard to argue that Italian suffering from Covid-19 is due to any budgetary indiscipline. Anti-euro feeling has increased in Italy - creating a dangerous juncture for the European project.

The equitable course would be to fund recovery at the same cost for every EU citizen. Not doing so fertilises the soil for anti-European parties. The danger is not that Spain and Italy spend too much - but too little.

Deep recessions and persistent growth divergence breed anti-establishment sentiment.

Solidarity matters when times are hard. The response to Covid-19 may be pivotal for public opinion on the European project if it does not want to become another victim of the pandemic.

The ECB is expected to increase its Pandemic Emergency Purchase Programme this week.

Many commentators believe that a proactive ECB and fiscal supports, bolstered by the proposed new €750bn EU Recovery Fund, are sufficient measures to reignite growth.

The €750bn fund correctly aims to provide mostly grants, not loans, though it requires unanimity and the 'frugal four' are likely to dilute the plan.

The other issue with the Recovery Fund is that leaders are emphasising the need for post-pandemic reconstruction in 2021, not curtailing the economic damage in 2020.

Preventing a larger recession now would minimise growth divergence across Europe. Combined with the evolving imbroglio between the German Constitutional Court and the ECB, cohesive European crisis response remains uncertain.

Irish companies and consumers face unparalleled uncertainty.

China, the source of cheap labour and cheap goods for decades, has won few friends and will remain under the US spotlight ahead of November's elections, raising questions for the sustainability of globalisation.

Bold political action from European leaders and Ms Lagarde can alleviate the pain of restoring public finances.

Interest rates will need to stay low, although the radical and innovative policies we are likely to see may have side effects on inflation and currency volatility.

Pearse Conaty is head of fixed income at Bank of Ireland Markets and Treasury

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