“Low interest rates alone cannot fight the virus”

Providing liquidity directly to borrowers could halt the financial chaos caused by Covid-19 more efficiently, says Moritz Sterzinger, director at Chatham Financial.

“The Bank of England (BoE) and Federal Reserve wanted to demonstrate their ability to act and avoid past mistakes of keeping monetary policy too tight for too long in the face of deteriorating economic conditions. It is clear that the COVID-19 pandemic will have severe effects on economic activity so rather than wait for data to confirm this, central banks are trying to pre-empt the upcoming slowdown and reduce the chance of a more severe financial crisis developing,” says Sterzinger.

“The fact that these measures were announced outside of regular meetings hasn’t really calmed down market participants. Low interest rates alone cannot fight the virus; providing liquidity to borrowers and the wider financial system are more important at this stage and likely to be much more effective.”

Sterzinger questions the efficiency of the central banks’ emergency cut, suggesting supply chains cannot be restored merely through the lowering of interest rates.

“In regard to central banks, the big question is whether their actions are going to do much and whether they are going to be very effective. If your issue is that you have production being halted, then the rate cut is not going to do anything about that. The rate cuts by the Federal Reserve and the Bank of England are not going to fix interrupted supply chains.”

“If you are quarantined in your home and cannot go outside – then again, such a rate cut is not going to help with respect to spurring consumption. What then can central banks realistically accomplish in such a situation? Is conventional monetary policy in the form of rate cuts going to be that effective at stabilising the economy? Maybe at the margin, but it’s probably not going to play a huge factor compared to fiscal measures.”

Prioritising cash flows

With stock markets continuing to plunge, Sterzinger says ensuring cash flow will be crucial for businesses.

“Central banks should be less concerned about stock market volatility and focus on making sure banks keep lending to businesses and that financial flows don’t seize up. The coordination between central banks and the swap lines between them announced on the weekend as well as the direction of the BoE and European Central Bank (ECB) lending programmes all suggest that central banks are emphasizing stabilising lending between banks and to the real economy.”

The European Central Bank (ECB) announced on March 12 that it will initiate a Targeted Longer-term Refinancing Operation (TLTRO) in order to facilitate lending from banks to SMEs. Banks will be penalised if they fail to assist small and medium businesses. Director of ECB Christine Lagarde assured the European bank will improve its quantitative easing by adding a “temporary envelope of additional net asset purchases of €120bn” until the end of the year.

Yet, the ECB’s package fails to meet all requirements, in which European countries in verge of a financial crisis will need further support in light of the coronavirus’ impact on production and supply.

“The ECB wanted to design a targeted policy response but failed to address concerns about how highly-indebted Eurozone countries with limited fiscal capacities can adequately respond to the economic damage the covid-19 outbreak is going to cause.  Therefore, the ECB might have to consider prioritising the purchase of Italian and Spanish government bonds for example, whose yields have shot up in recent weeks, in order to take off some of the fiscal pressure these countries are facing,” says Moritz.