ECB Prods Governments to Get on With Spending in Virus Fight

European Central Bank President Christine Lagarde has cleared the path for governments to do whatever is necessary to counter the economic blow from Covid-19’s second wave -- just so long as they crank up the spending.

With her unequivocal pledge Thursday to “recalibrate” monetary support by December at the latest -- a phrase widely understood to mean more stimulus is coming -- Lagarde in effect told leaders from Rome to Berlin that borrowing to battle the virus will be backstopped by her institution in Frankfurt.

ECB Prods Governments to Get on With Spending in Virus Fight

The question, though, is whether politicians can overcome their own squabbles. Talks on an unprecedented 1.8 trillion-euro ($2.1 trillion) budget and jointly-financed recovery fund are currently deadlocked, even as households and businesses face fresh lockdowns and uncertainty over how they’ll pay the bills.

ECB Prods Governments to Get on With Spending in Virus Fight

That puts national governments at the vanguard, and they have wildly varying access to resources. Germany has pledged 10 billion euros for businesses hurt by the latest lockdown -- and far more on wage support for workers -- but Italy is making do with half that even amid growing unrest. Another recession looks increasingly likely.

Following the ECB’s regular meeting in Frankfurt, Lagarde made an unusually clear promise to use the next meeting in December to reassess all its tools, which include negative interest rates, bond purchases and cheap loans to banks. That’s because the economy is losing momentum “more rapidly than expected.”

Top central bankers in Europe and the U.S. have repeatedly urged politicians to increase spending because monetary policy alone can’t easily stimulate demand. The start-stop approach from governments highlights one of fiscal policy’s key weaknesses: while it packs a bigger punch, it can take longer to deliver.

On Friday, Executive Board member Yves Mersch said that the amount of public spending will be taken into account when the central bank is evaluating its next stimulus injection.

“We have encouraged the fiscal side to expand its intervention in view of the challenges that we are facing inside Europe,” he said during a virtual event hosted by UBS AG.

European leaders have been caught short by the speed with which the summer lull in virus cases has turned into an autumn surge, with thousands of people falling sick every day in countries across the bloc.

Data on Friday showed rising unemployment and falling prices. Governments are under pressure to keep delivering the wage support and payouts that carried companies and households through the first lockdowns.

“Economically, it is really grave right now,” said Guntram Wolff, director of the Brussels-based Bruegel think tank. “The economic recovery is coming to a halt. If we are lucky it’s going to be zero growth, but it can easily be negative -- even in Germany -- in the fourth quarter.”

The ECB’s massive liquidity injections through bond purchases have made the task of public authorities easier by driving borrowing costs to near-record lows. German benchmark yields are at their lowest since lockdowns in March. Italian borrowing costs had their biggest drop since June on Thursday.

Fiscal Deadlock

But a much bigger concern is that the European Union’s 1.8 trillion-euro budget and jointly-financed recovery fund, where talks are deadlocked over the rules under which the money can be tapped. That’s making investors nervous.

The key concern is Italy, the bloc’s third-biggest economy, with its debt burden near 160% of economic output. It is the biggest beneficiary of both the pandemic purchase program and the plans for the 800 billion euro recovery fund.

Failure to deliver the latter could blow out bond spreads given any extra borrowing would have to be taken on the nation’s own books, rather than shared across the bloc.

Lagarde made a heartfelt plea on Thursday for governments to recognize that “an ambitious and coordinated fiscal stance remains critical.” Failure to listen could mean that another of the president’s pledges -- to take extraordinary action even before its December meeting if needed -- may be activated.

“The EU had better not disappoint,” said Luke Hickmore, a money manager at Aberdeen Standard Investments. “The ECB can’t keep throwing more cash in because it will definitely start to wane in its impact.”

©2020 Bloomberg L.P.

BQ Install

Bloomberg Quint

Add BloombergQuint App to Home screen.