Oliver Mangan: Interest rates set to be cut to stem economic fallout from coronavirus
After a stellar 2019, we warned in this column at the start of the year that investors seemed very complacent and were “ill-prepared for shocks, meaning they are vulnerable to unexpected bad news”.
However, we did not foresee the extent of the carnage of the past week. All the main stock markets plummeted by 12% to 3%, while 10-year US Treasury yields fell to record lows.
The speed of the slide has been staggering. Investors had become overly reliant on directional trading in a rising stock market.
The global economy had appeared to have turned a corner over the winter months. It looked to be starting 2020 on a firmer footing after losing momentum over the previous 18 months.
However, the disruption to economic activity caused by the efforts to contain the coronavirus outbreak, including the impact on supply chains, tightening financial conditions, cancellation of spending plans and heightened uncertainty will almost certainly see the signs of a global pick-up snuffed out in the next couple of months.
Indeed, manufacturing data for February from Japan, South Korea and especially China show clear signs of a contraction. With markets in turmoil, central banks are unlikely to stand idly by and can be expected to act soon.
The US Federal Reserve issued a rare statement on Friday saying it would use its policy tools to support the economy given the risks to activity posed by the coronavirus.
The Fed has the most scope for manoeuvre and markets are now expecting a rate cut of 50 basis points at its next policy meeting which starts on March 17. A further 50 basis point in easing is anticipated over the summer.
Markets are discounting that the Bank of England will cut rates by up to 50 basis points. The Bank of Japan and the ECB, which have less room for action as interest rates are already negative, are expected to ease policy by 20 basis points. Governments may also loosen fiscal policy to support economic activity.
It is not the coronavirus itself, but the efforts to contain it that are affecting economic activity and financial markets.
To put the coronavirus in context, in each of the last two winters in the US, over 40 million people got the flu, almost 1 million people required hospitalisation, and deaths from flu were reported at 60,00 to 70,000. These figures are not out of kilter with other years.
It is also the case that the vast bulk of coronavirus cases are mild, unlike the Sars virus, and largely confined to four countries, so far. However, there is a lot of panic, and authorities have the difficult task of weighing measures to contain the spread of the virus against the impact on economic activity.
Given all this uncertainty, central banks look certain to act soon and loosen policy to help calm markets and support economic growth.
