Central Banks Just Starting Virus Fight With Record Low Rates

(Bloomberg) -- Global central bankers are cutting interest rates beyond their financial crisis-era lows, underscoring the hit to economies from the coronavirus even as investors question the healing powers of monetary policy.

The average of benchmark borrowing costs set by 38 key monetary authorities has now dropped to a record of around 3%, according to a measure compiled by Banque Pictet & Cie. That follows this week’s actions by the Federal Reserve and Bank of Canada to reduce rates by half a percentage point, and easing by the Reserve Bank of Australia too.

Such an outcome is a reversal from how most policy makers envisaged spending 2020, amid expectations that global growth was strengthening. Instead, the virus has roiled markets and risks consigning the world economy to its weakest year since 2009.

Economists see the People’s Bank of China, Bank of Japan, European Central Bank and Bank of England also acting this month, among others. They predict the Fed will move again too.

Here’s a closer look at what we learned in the past few days.

Central Banks Are Worried

Gone is the view of late February that it was premature to tell if the virus would have a lasting global economic impact. Those hopes were dashed by its spread beyond China and sliding stocks.

Originally limiting supply by shuttering Chinese factories and forcing workers to stay home, the disease is now curbing demand worldwide.

The OECD this week said an intensive outbreak could slash global growth to 1.5% in 2020. Bloomberg Economics says if the whole world repeats China’s experience its economy would grind to a halt over the year, costing $2.7 trillion in lost output.

Group of Seven finance chiefs pledged to use “all appropriate policy tools” to safeguard economies.

The Fed was so worried, it then acted outside its normal schedule for the first time since 2008 in an effort to shore up confidence, financial conditions, access to credit and demand.

“We need to be mindful that the impact from the outbreak could be big,” said BOJ Governor Haruhiko Kuroda.

The Cuts Aren’t Cutting It

Having pushed for action, investors were still not happy, as stocks continued falling and the 10-year Treasury yield, a benchmark for global borrowing, dipped to a historic low of 0.9043% even after the Fed announcement.

The reason: Central banks aren’t omnipotent. They can’t cure a virus, mend supply chains or spur people to shop when there’s a health emergency.

They are also low on ammunition, which perhaps explains the lack of 2008-style coordinated cuts this week. The Fed’s benchmark is now not far from zero, while those of the ECB and BOJ are already negative.

The Cuts Will Keep Coming

But central banks will keep acting. Outgoing BOE Governor Mark Carney says policy makers will deliver a “powerful and timely” defense.

China’s economy will shrink in the first quarter on a quarterly basis, and global manufacturing contracted in February by the most since 2009. Other measures of economic health will soon worsen.

Most central banks were already undershooting their inflation targets. While some wonder if lower supply will force up prices, the consensus is for inflation to fade -- and that will need offsetting.

“For us, what really matters of course is not the epidemiology, but the risk to the economy,” Fed Chairman Jerome Powell said on Tuesday. “We saw a risk to the outlook for the economy, and chose to act.”

Bloomberg Economics predicts the Fed will cut another 50 basis points in coming months. The U.S. central bank followed its last six emergency reductions with further moves, so could act as soon as its March 17-18 meeting.

The ECB will reduce its deposit rate by 10 basis points next week, and the BOE will trim its benchmark by a quarter point later this month, according to Bloomberg Economics.

It sees the People’s Bank of China dropping the one-year loan prime rate 40 basis points over the rest of this year, with the next move expected on March 20.

Other Tools to Be Used

While the Fed prefers classic cuts, others may be more inventive. Those with negative rates inflicting side effects on banks may need to use other tools, which they can target at weak spots such as cash-strapped companies.

The BOJ has already boosted buying of equity exchange-traded funds, and people familiar with the matter say it is likely to consider a new lending program to help companies.

Previously under attack from banks for negative rates, the ECB could also issue cheaper funding to financial institutions that lend it on to businesses, specifically small ones.

The BOE may also tweak its lending program for banks, and incoming Governor Andrew Bailey suggests uniting with the government to bridge loans to companies. The U.K. budget is next week.

Others have already acted. The PBOC is extending 800 billion yuan ($115 billion) of loans to small companies. The Bank of Korea held rates but raised a cap for cheap loans. Indonesia lowered the amount of money lenders need to hold.

Governments Need to Help

Short of firepower, central bankers want help from governments despite their own debt burdens.

Fiscal policy is also sharper than monetary policy. It can be directed to health care or struggling companies.

Already, China has pledged a “more active” fiscal policy, while South Korea, Malaysia, Singapore and Indonesia are among those crafting stimulus packages. Italy is deploying tax credits and Hong Kong is offering cash handouts.

The U.S. seems more reluctant, although the House passed a $7.8 billion emergency spending bill. But President Donald Trump has balked at pursuing a major fiscal plan, and aides say he is not considering a payroll tax cut or a rollback of tariffs on China.

The Future

The Fed and ECB are already conducting reviews of how they set monetary policy. Tackling the virus is acccelerating the debate and the Fed should consider committing to easy monetary policy and modifying its inflation target, said David Wilcox of the Peterson Institute for Internatrional Economics.

Ultimately, the virus has highlighted the need for better fiscal and monetary policy coordination despite the traditional walls between central banks and governments.

“We must act in a coordinated fashion,” the U.K.’s Bailey said. “We can’t let our notions of independence get in the way of us.”

What Bloomberg’s Economists Say...

“Central banks and finance ministries face different types and intensities of shock, with differing policy space to react. Containing the spread of the virus has proved hard. Containing the economic fallout won’t be any easier.”

-- Tom Orlik, chief economist

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To contact the reporter on this story: Simon Kennedy in London at skennedy4@bloomberg.net

To contact the editors responsible for this story: Stephanie Flanders at flanders@bloomberg.net, Craig Stirling

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