Governments to the rescue?

In this past week we have witnesses a massive ramping up of action taken by national governments and central banks across the world as they seek to win the battle against the health and economic impact of the Coronavirus pandemic.

It is crucial that our financial system continues to provide liquidity to businesses and families so that we can all withstand the impact of the collapse in activity and cash flow. National governments are seeking to directly support business and households with direct aid to see us thought this, in order that we are able to quickly bounce back.

The UK government is going to protect the jobs of the UK workforce by promising to pay 80% of income up to a maximum of £2,500 for at least 3 months and maybe longer. This will allow employers to stand down staff to slow the spread of Coronavirus and avoid mass unemployment. Companies now have the confidence to keep workers on even if they are inactive. This allows the county’s productive capacity to be quickly engaged when some form of normality returns. The Chancellor is under pressure to announce similar support to the self-employed. Sectors of the economy will also be expecting announcement over support packages such as airports and airlines.

It illustrates that the Treasury believes that the impact of Covid 19 upon our economy can and will be followed by a recovery. This would not be the case if millions of people were out of work and economically inactive.

Actions of this nature are unprecedented and are being rolled out in many other countries. These are the actions of governments transforming the social safety net and seeking to prevent at all cost a depression.

The underwriting of salaries and the improvements to universal credit and housing benefits, came just days after the Chancellor launched a range of financial measures including a £330bn government backed loan scheme, £30bn of business grants, a 12 month freeze on business rates and £1bn in renters support. The Bank of England has cut interest rates twice, from 0.75% to 0.25% and now to 0.1%, the lowest UK interest rate ever. On top of this the BOE offered mortgage holders a 3 month mortgage holiday.

The BOE are also purchasing up to £200bn of UK government and corporate bonds in order to put cash into the economy and stabilise the yields on UK bonds. Yields have been rising due to bonds being sold off by investors seeking the security of US$. When bonds are sold prices fall and yields consequently rise. This then increases the cost of borrowing. The government wants to lower the cost of borrowing as it is now planning to borrow huge sums of money. With the BOE buying bonds the price will rise and yields fall. The BOE is planning for a very steep V shape decline and recovery in economic activity.

The BOE are expecting to use the war chest it had built for a hard Brexit in order to support the value of sterling by intervening in currency markets.
Fears over a wave of company failures have prompted lenders to pull £55bn out of the UK corporate bond market. These actions where led by the large insurance companies, faced with soaring claims and falling asset prices have sought to liquidate investments for cash. Insurance companies are braced for a record £275m claims bill for cancelled holidays.

Some economists are suggesting hundreds of thousands of job loses despite government support. UK unemployment is currently 3.9% and hit a high of 8% in 2010 after the financial crisis. Capital Economics are predicting a 6% unemployment level, however the government is making unprecedented endeavours to minimise unemployment.

The closure of schools will have a major impact on the economy as millions of workers will be forced to look after young children. It is expected that 2 million workers are likely to have to take care of children. This impact has now been somewhat reduced by the government temporarily underwriting wages.
The US Federal Reserve has acted with decisiveness and launched a programme of US$700bn worth of quantitative easing aimed at buying US Treasuries and Municipal Bonds. The Fed also cut interest rates to 0%-0.25%. The government will also be making payments to employees taking unpaid leave and expanding unemployment benefits. They are also planning to pay every American household US$1000 directly.

The ECB have been criticised for doing too little to support the Eurozone. The ECB Chair Christine Lagarde’s epic blunder of hinting that the ECB would not stand behind Italian bonds sent bond yields soaring and was quickly retracted. The impact pushed Germany to support a massive ECB stimulus package and a bail out that underpins the Euro. The ECB launched an €750bn package aimed at buying Eurozone government bonds and company debt which importantly included that of Italy and Greece. The support to Italy is crucial as the country is facing the most desperate times in the battle for public health and financial stability. This package comes on top of €120bn of the recently renewed QE programme.

Separate to ECB monetary stimulus, the Eurozone governments are adding fiscal measures. Germany for example has announced €500bn loans to business and is expected to borrow a further €350bn to fund an economic support package. This borrowing alone amounts to 10% of German GDP.
Economist are downgrading forecasts for the global economy. Morgan Stanley is warning that global GDP will fall by 5.1% in 2020 after a deep recession in Q2. They believe that even a strong rebound in activity in Q3 and Q4 would not prevent a recession. The level of recession will without doubt depend upon the extent of government action. The Centre of Economic and Business Research (CEBR) is suggesting that the world economy will shrink by 4% this year. The CEBR said that staving off a thirties style depression is a top priority for policy makers.

Governments and central banks around the world are co-ordinating the launch of a monetary and fiscal bazooka. There is no past example of the scale and violence of the forces at play against us and the response from governments to beat the virus.

After the rebound, governments will be holding very high levels of national debt as well as for a time lower tax receipts. For this reason we expect interest rates for savers to stay very low for the next 5 years.

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