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Economic Research: COVID-19: The Steepening Cost To The Eurozone And U.K. Economies


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Economic Research: COVID-19: The Steepening Cost To The Eurozone And U.K. Economies

The economic costs of the coronavirus pandemic for Europe are mounting quickly as measures to contain the virus increase, both in the region and abroad. The eurozone and U.K. economies are now facing a recession of -2% for 2020. The recovery that we expect to start in the second half of 2020 will take time, as job losses and uncertainty will slow the return to previous levels of consumption, investment, and trade (see chart 1 and table 2 below for S&P Global Ratings' detailed economic forecast). Risks to our forecast are skewed to the downside: The pandemic might last longer and be more widespread than we currently envisage. The size and kind of policy responses countries take now are key to avoiding permanent economic damage later.

Chart 1


Coronavirus' rapid spread puts European economies on hold

Most of the multiple shocks to the European economy are growing, such as the shock to demand, both internal and external, and the shock to supply. And then, there is the shock to confidence from a sharp tightening in financial conditions and uncertainty about the length of isolation measures. Only monetary conditions have stabilized since our last assessment (see "Disorderly Appreciation Of The Euro Might Inflict Longer-Lasting Economic Harm Than COVID-19," March 13, 2020). The euro especially erased all of its previous gains after the European Central Bank opened standing foreign exchange swap lines with other major central banks to cope with strong demand for U.S. dollars by corporates that are hoarding cash.

Chart 2


On the demand side, constraints to consumption are now the main channel of disruption for European economies

The unprecedented drop in household consumption, a result of social distancing and lockdown measures taken to contain the spread of the virus, is the main channel that is disrupting European economies. Looking at the current containment measures imposed by governments in Europe, we think it is reasonable to assume lockdowns will last until the end of April. During lockdowns, we estimate households will have limited access to non-essential purchases, reducing spending by about 40%. Moreover, the rapid spread of the virus in the U.S. adds another risk to external demand for European exporters, as the country is the EU's biggest destination for goods exports.

On the European supply side, in addition to disruptions to supply chains ("The Coronavirus Will Shave 50 Basis Points Off Eurozone Growth," March 4, 2020) and a lack of demand for goods and services, domestic activity is also suffering from a partial labor shortage as workers stay home. Several manufacturers have already announced the closure of plants because of shortages of inputs or to protect their workers' health, while others are running at lower capacity due to a lack of demand for their products. School shutdowns are also likely to take a toll on employees' productivity. All of these factors will add constraints on economic activity.

The rapid drop in market confidence over the past weeks and uncertainty about when things might return to normal is also weighing on the economic outlook. Firms are more reluctant to create jobs and invest, which will lead to the gradual recovery we now expect, once containment measures are lifted. People will probably remain reluctant to travel for some time, and companies might reconsider reestablishing their supply chains across borders.

Monetary and fiscal authorities take extraordinary measures to limit the damage

Positively, European countries and central banks have been quick to activate safety nets and inject liquidity into their economies. This should support the recovery in economic activity once containment measures are lifted. Their actions seek to ensure that especially small and midsize enterprises continue to have access to credit and don't shed jobs.

On the fiscal side, most countries have unveiled large rescue packages (see table 1). For the most part, these are not public expenditures to substitute for the fall in private demand. Instead, about two-thirds of these packages comprise government loan guarantees. They are aimed at helping businesses and mortgage lenders deal with the containment and avoid a more severe rise in nonperforming loans and defaults. Another component are short-time working schemes, introduced by Germany, France, Italy, the U.K., and Spain to avoid massive layoffs as entire sectors of the economy are forced to shutter. The basic idea of such schemes is for the state to subsidize companies' payrolls to prevent employers from reducing staff in response to a temporary fall in activity. This will ensure that consumption can recover swiftly once containment measures are lifted.

The German government first introduced short-time working arrangements in 2008 during the Great Recession. This measure contained a surge in unemployment to half a percentage point in 2009 even though the output gap opened by 6 points (see chart 3). In Germany, the eligibility criteria for short-time work subsidies are much more flexible than in 2009. In France, claims on short-time work have soared by more than 400,000. Meanwhile, European companies will also benefit from tax credits and deferrals so they can cope with the declines in revenue.

As for monetary policy, central banks have tailored their response to ensure that businesses have access to credit through banks or the market, and that the cost of funding remains manageable.

Chart 3


Chart 4


The ECB's more favorable refinancing operations for banks should ensure they do not tighten credit at a time when businesses need access to liquidity. The reintroduction of long-term refinancing operations (LTROs) priced at the deposit facility rate lowers the cost of three-month liquidity for banks by 50 basis points (bps). Moreover, banks can earn 25 bps just by keeping the size of their loan book unchanged, now that the ECB raised the volume of targeted LTROs (TLTROs) by some €1.2 trillion and made them more attractive by reducing their refinancing rate to 25 bps below the deposit rate. Finally, the ECB's Supervisory Board called on national authorities to relax capital requirements to give banks more room.

In parallel, the Pandemic Emergency Purchase Programme (PEPP) is a clear statement and a strong signal that the ECB is not running out of tools. It will ensure that governments and companies are not shut out of the market at a time of higher borrowing needs (see chart 4), and comes on top of the central bank's other purchasing programs. The flexible €750 billion program, which is to run until at least to the end of 2020, coupled with the ECB's other quantitative easing measures, amounts on average €107 billion in net monthly purchases until the end of the year--more than 0.9% of eurozone GDP. This program is therefore bigger, in monthly flow, than any of the ECB's other asset purchase programs. It is also unconditional (unlike the Outright Monetary Transactions programme), flexible across time and asset classes, and encompasses more assets, with the ECB adding Greek bonds as well as nonfinancial commercial paper to other assets already eligible under its other programs. In practice, the PEPP also has no limit. As the ECB recently said, "The Governing Council is fully prepared to increase the size of its asset purchase programmes and adjust their composition, by as much as necessary and for as long as needed," with the self-imposed 33% issuer limit to be revised if necessary.

The Bank of England (BoE) also had a bold response. It decided to increase its holdings of U.K. government bonds and sterling nonfinancial investment-grade corporate bonds by £200 billion to a total of £645 billion. The BoE cut the bank rate twice within a few days, to 0.1% currently, the lowest ever, and increased the base of applicable loans to the new term funding scheme for SMEs (TFSME) to 10% from 5%. Moreover, the BoE cancelled the 2020 stress test for the eight major U.K. banks and building societies. This came less than a week after it announced a Covid Corporate Financing Facility (CCFF) to provide additional help to firms. The CCFF will be active for 12 months at least, is unlimited in size, and will provide funding to qualifying businesses by purchasing commercial paper of up to one year's maturity.

The U.K. government has also deployed coronavirus emergency measures aimed at liquidity support for businesses and the direct prevention of large-scale job losses. These include a Business Interruption Loan Scheme, offering an 80% guarantee to banks on loans to SMEs; tax deferrals (VAT, income tax) and outright breaks (business rates); reimbursement of sick pay; and the Coronavirus Job Retention Scheme, where the government continues to pay 80% (up to a cap) of wages for employees who otherwise would have been laid off.

Bigger policy responses should lead to faster economic recovery. Although European countries have taken similar fiscal measures, they do not have the same fiscal space. France and Germany's partial unemployment schemes are better funded than the Italian or Spanish ones, and their loan guarantees are more sizable. Spain and Italy also have a higher share of independent SMEs, which are likely to bear the brunt of the economic shocks. For these reasons, we believe the French and the German economies will rebound more quickly.

Fiscal measures are unlikely to spur higher inflation, and we should expect lower rates for longer

In spite of the large sums of liquidity injected into the economy from fiscal and monetary policy authorities, we do not expect runaway inflation. Aside from preventing a credit crunch, a deeper recession, and deflation, the injection of liquidity is also meant to help companies survive the shock and resume production once the pandemic subsides. The state guarantee schemes are there to provide security for banks concerned about recessionary conditions. What's more, we believe people and companies will hold a large part of the liquidity that central banks inject as cash, as happens in uncertain times.

Because the drop in demand will have a greater effect on growth than the supply shock, disinflation will prevail, and we now expect inflation at 0.6% this year (down from 1.2% previously, see chart 5) in the eurozone and 0.9% in the U.K. One contributing factor is the oil price war between Russia and Saudi Arabia, which has led to plummeting oil prices and will result in lower energy prices in Europe. The recession and loss in revenues that comes with it also mean that companies are unlikely to lift wages by much this year and next. Finally, prices in most affected sectors (like tourism and retail) could also drop when things return to normal, as firms seek to attract customers back. This also means that rates will stay lower for longer as central banks will need to wait to bring inflation back up to their target levels. As such, we think the ECB will not be able to lift rates before 2023. Having said that, we expect the euro to resume appreciating against the U.S. dollar once activity normalizes.

Chart 5


Risks to our forecasts remain on the downside as Europe navigates into the unknown

For now, we expect a rebound in 2021 by 3% in the eurozone and by 3.8% in the U.K. However, darker clouds are on the horizon, given a high degree of uncertainty.

Several pandemologists suggest that social distancing or lockdowns might have to be in place much longer to be effective and ensure that health care systems can cope with cases of COVID-19. For example, Ferguson et al. estimate that to be effective, suppression measures will need to be maintained until vaccines are available, that is, 18 months ("Impact of non-pharmaceutical interventions (NPIs) to reduce COVID-19 mortality and healthcare demand," March 16, 2020).

While China's and South Korea's experiences suggest current lockdown strategies might contain the spread of the virus, there is still a risk it survives the summer, and we see a second wave of infections in the autumn before a cure has been found. This scenario could require the reapplication of containment measures and thus reduce economic activity again later this year. For now, it seems the curve in Europe is steeper than it was in South Korea or in China (see chart 6). Although the pandemic is global, it's unclear what the damage to economies will be worldwide. For example, a more pronounced recession in the U.S. than we currently expect would deepen the hit to European exporters, as would a larger impact to emerging markets, excluding China.

Based on our current forecast assumptions and a quick back-of-the-envelope calculation, a scenario of four months of social distancing would likely lower eurozone GDP by 10% this year. Under that scenario, we see a 13% recovery in 2021 (see chart 7).

On the positive side, we observe that the current turmoil on European financial markets is less intense than in 2008 or 2012, according to the ECB's composite indicator of systemic stress. Notably, the cross correlation among assets classes is negative, suggesting that market liquidity is not drying up for all asset classes but that squeezes are moving from one market segment to another.

Chart 6


Chart 7


Chart 8


Table 1

Large Fiscal Measures To Bridge The Economic Fallout Of The Coronavirus Pandemic
Germany France Spain Italy U.K.
Credit support for firms €50 billion direct payments to self-employed and small firms; €600 billion Economic Stability Programm including €400 billion loan guarantees for firms to facilitate refinancing on capital market, €100 billion to the state-owned KfW in order to finance emergency credit programm, €100 billion recapitalization measures to provide liquidity to firms; €357 billion increase of the guarantees to KfW in order to enable it to provide ample liquidity to corporates (total guarantees to the KfW now amount to €822 billion with the possibility of a further 30% increase). €6 billion of new loans, as well as: - around €300 billion of firm loan guarantees for banks - solidarity fund for SMEs and self-employed (€1500 direct cash handout and €1 billion of credits available). €100 billion of guarantees by the government to grant frims' liquidity (this is to be completed by €83 billion from the private sector). - €10 billion increase in financing capacity for corporate sector via Instituto de Credito Oficial (State Owned Development Bank). - €2 billion increase in insurance for exporting SMEs from Cesce. - one month moratorium on mortgage and rental payments for vulnerable households. €5 billion set aside to enable: - grace period for around €220 billion of loans for SMEs and self-employed until 30/09/2020 - guarantee around €100bn of loans guaranteed via the Fondo Centrale di Garanzia per le PMI - first-time buyers to suspend mortgage payments. £330 billion: the government will provide lenders with a guarantee of 80% on each loan to SME's (subject to a cap on claims to each lender).
Job guarantee €10 billion short-term working scheme (the state pays 60%-67% of the usual salary for unworked hours; 10% of employees need to be concerned for firms being eligible to the scheme, from 30% previously); estimate. €5.5 billion added to the partial unemployment scheme (the state takes over 100% of the unworked hours up to 4.5 times the minimum wage). €5 billion partial or temporal unemployment scheme - employees receive unemployment benefits independent from their contributions and these benefits will not be deducted from their contributions. - Firms are exempted from social contributions (75%-100% according to firm size). - €10.2 billion to guarantee employment income for all via the "cassa integrazione" (employees get 80% of their income in this situation of partial unemployment for the next nine weeks) - suspension of redundancy procedure from the Feburay 23 for 60 days. £5 billion: For workers otherwise laid off, the government will pay 80% of workers wages (capped at £2500 a month). This applies to all businesses. (Estimate assumes 5% of the workforece are affected till end of June).
Tax payment suspensions Tax deferrals (firms suffering from tight liquidity as a result of the COVID-19 crisis can apply until Dec 31 for deferrals of taxes due this year. Applies to income tax, corporate tax, sales tax). €35 billion of social contribution and tax deferrals. €14 billion tax deferrals to self-employed and SMEs. €2.4 billion for tax payment deferrals and tax credits. £20 billion extra spending as part of: (1) VAT payment deferral from March 20 to June 30 for all businesses; (2) Income Tax payments for self-employed defferred to January 2021; Business rates holiday for FY 2020-21 for Retail, Hospitality, and Leasure Businesses, plus a cash grant of up to £25.000 per property in England.
Health care spending €3.5 billion €2 billion €3.8 billion €3.2 billion £5 billion for the National Health Service and social services.
Other measures €55 billion emergency budget; €8 billion social benefits; €6 billion guarantee provisions. €300 million for Extraordinary Social Fund via Regions for care workers; €25 million in meal allowances. £4 billion for social benefits: Increase in the annual standard allowance of Universals Benefit by £1000 a year. Estimate by the Institute for fiscal studies.
Total disbursed €156 billion*, 4.5% of GDP €45 billion, 2% of GDP €23 billion including tax deferrals (1.9% of GDP), €9 billion otherwise (0.7% of GDP) €20.2 billion, 1.1% of GDP €39 billion (£34 billion), 1.5% of GDP
*Includes an estimated loss of tax revenues of €33.5 billion. FY--Financial year. SMEs--Small and midsized enterprises. Source: S&P Global Ratings.

Table 2

S&P Global Ratings European Economic Forecasts (March 2020)
GDP Germany France Italy Spain Netherlands Belgium Eurozone U.K. Switzerland
2018 1.5 1.7 0.7 2.4 2.5 1.5 1.9 1.3 2.8
2019 0.6 1.3 0.2 2.0 1.7 1.4 1.2 1.4 0.8
2020 (1.9) (1.7) (2.6) (2.1) (1.6) (1.7) (2.0) (1.9) (1.8)
2021 2.6 3.2 2.9 3.1 2.7 2.6 3.0 3.8 4.0
2022 1.2 1.9 0.9 1.7 1.5 1.3 1.5 2.2 2.1
2023 1.1 1.8 0.9 1.6 1.5 1.2 1.5 1.5 1.9
CPI Inflation
2018 1.9 2.1 1.2 1.7 1.6 2.3 1.8 2.5 0.9
2019 1.4 1.3 0.6 0.8 2.7 1.2 1.2 1.8 0.4
2020 0.9 0.8 0.2 0.9 0.8 1.0 0.6 0.9 (0.3)
2021 1.5 1.5 1.1 1.4 1.5 1.8 1.3 1.5 0.4
2022 1.4 1.7 1.3 1.5 1.4 1.8 1.5 2.1 0.6
2023 1.3 1.7 1.3 1.6 1.4 1.8 1.5 2.0 0.7
Unemployment rate
2018 3.4 9.1 10.6 15.3 3.8 6.0 8.2 4.1 4.7
2019 3.2 8.5 9.9 14.1 3.4 5.4 7.6 3.8 4.4
2020 3.5 8.9 10.6 14.7 3.4 5.5 7.9 4.5 5.0
2021 3.4 8.7 10.4 15.6 3.4 5.9 7.9 4.4 5.0
2022 3.3 8.3 10.0 15.2 3.3 5.8 7.6 3.8 4.7
2023 3.2 8.1 9.6 15.0 3.3 5.8 7.4 3.7 4.3
10-year Government bond
2018 0.46 0.78 2.61 1.42 0.58 0.80 1.17 1.46 0.05
2019 (0.21) 0.13 1.95 0.66 (0.06) 0.20 0.41 0.94 (0.47)
2020 (0.44) (0.03) 1.50 0.58 (0.23) 0.05 0.18 0.57 (0.51)
2021 (0.46) (0.07) 1.44 0.39 (0.28) 0.01 0.20 0.95 (0.55)
2022 (0.30) 0.09 1.67 0.51 (0.10) 0.14 0.39 1.46 (0.44)
2023 (0.15) 0.32 1.88 0.67 0.06 0.36 0.56 1.87 (0.30)
Eurozone U.K. Switzerland
Exchange rates USD per Euro USD per GBP Euro per GBP CHF per USD CHF per Euro
2018 1.18 1.34 1.13 0.98 1.15
2019 1.12 1.28 1.14 0.99 1.11
2020 1.09 1.23 1.13 0.97 1.06
2021 1.12 1.30 1.16 0.99 1.11
2022 1.15 1.34 1.16 1.00 1.15
2023 1.18 1.38 1.17 1.00 1.18
Eurozone (ECB) U.K. (BoE) Switzerland (SNB)
Policy rates Deposit Rate Refi Rate
2018 (0.40) 0.00 0.60 (0.75)
2019 (0.44) 0.00 0.75 (0.75)
2020 (0.50) 0.00 0.23 (0.75)
2021 (0.50) 0.00 0.16 (0.75)
2022 (0.50) 0.00 0.58 (0.75)
2023 (0.23) 0.00 1.09 (0.50)
Source: S&P Global Ratings.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak around midyear, and we are using this assumption in assessing the economic and credit implications. In our view, the measures adopted to contain COVID-90 have pushed the global economy into recession and could cause a surge of defaults among nonfinancial corporate borrowers (see our macroeconomic and credit updates here: As the situation evolves, we will update our assumptions and estimates accordingly.

This report does not constitute a rating action.

Senior Economist:Marion Amiot, London + 44 20 7176 0128;
Boris S Glass, London (44) 20-7176-8420;
EMEA Chief Economist:Sylvain Broyer, Frankfurt (49) 69-33-999-156;
Economist:Sarah Limbach, Paris + 33 14 420 6708;

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