In Europe the Crisis Policy Response Is Substantial, But More Is Likely Needed

Over the past few weeks, European countries have stepped up virus containment measures aggressively, with most of the region now in lockdown. Gauging the exact economic impact of these measures is hard, but it is almost a certainty by now that Europe will experience a very deep recession, with falls in gross domestic product (GDP) in the double-digits, in annualized terms, during the first half of the year.

While the near-term GDP decline will most likely exceed the hit experienced during the 2007-2008 financial crisis, the difference this time is that the recession is not driven by fundamental imbalances, but by disruptions in activity caused by self-imposed virus containment measures. This means that, as deep as it may be, the recession does not need to be long and could be followed by a sharp rebound, in what could look like a V- or a U-shaped recovery.

While this is our base case, it is not a given. The conditions for a relatively quick and robust rebound rest on 1) the success in containing the virus within a reasonable horizon, and 2) a well calibrated economic policy response which avoids a prolonged economic and financial fallout from what will be a sudden stop for the European economy.

Containment of the virus rests on governments’ determination to stop the spreading of infections and on people’s willingness to comply with the guidance given. China appears to have managed to control the virus within weeks. In Italy, the European country where the virus first started to spread rapidly, there are some encouraging signs from the slowdown in the daily growth rate of Covid-19 cases in response to draconian government policies, although these signs remain tentative so far. Other countries, arguably, are further behind in the process, although the more aggressive containment efforts implemented recently should start to yield some results in the coming weeks.

Regarding economic policy, efforts have been stepped up meaningfully. The European Central Bank (ECB) decided to add at least another EUR 870 billion (bn) to its quantitative easing (QE) programme in 2020, launched cheap liquidity operations for banks and eased the regulatory burden for the financial sector. The Bank of England (BoE) has launched a wave of similar easing measures too. Fiscal authorities across the region, meanwhile, have adopted fiscal easing packages worth 1%-4% of GDP, have offered credit guarantees aimed at making liquidity available to solvent companies and households; and introduced measures to protect household incomes at a time of significant disruption.