Interest Rate Cuts Ineffectual in Fighting Coronavirus Slump, Recovery Only Likely in 2nd Half 2020

- Rate cuts won't save economy from Coronavirus slump
- No sharp recovery likely
- Govt. fiscal support key to mitigating major slump

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The economic impact to the world's economy from the coronavirus is likely to last for a number of months with some economists saying a recovery to economic activity is only likely in the second half of 2020, meanwhile central bank interest rate cuts are unlikely to help warns a note City economist.

David Bloom, HSBC's senior foreign exchange analyst, hit the airwaves on Friday to explain why central bank interest rate cuts do not help when a crisis is an issue of a lack of supply:

"I'll use toilet paper as the example, only because there has been panic buying of toilet paper... if there is nothing available in the shop and someone gives me £100, I say 'OK I couldn't get it', and then I get given £1000, I say 'but it is not available!'" Bloom told CNBC.

The coronavirus is a shock to the supply side of the economy: the UN estimates that the supply chain to global manufacturers owing to the Chinese economic shutdown stands at £50BN.

"The problem is it's a supply side problem and throwing money at a supply side problem may not help" adds Bloom, "that's why people are sceptical of central banks cutting rates."

This crisis therefore differs notably to the 2008 crisis where the fundamental problem was a ceasing up in the supply of finance to a debt-laden global economy.

However, this does not mean authorities should just sit back as there now comes an onus on governments to lend fiscal support to the economy.

"The fiscal side I totally agree with, helping people with 0 interest rate overdrafts and things like that while they are in a cashflow problem is different," says Bloom, "this isn't a financial crisis."

Jon Harrison, Managing Director, Macro Strategy at TS Lombard, says China's response to the outbreak of the coronavirus has in fact been a considerable success, in part owing to the fiscal support the Government offered.

"A comprehensive lockdown, aggressive fiscal stimulus and debt forbearance will drive an economic recovery beginning in Q2," says Harrison. "China’s response represents a template that other countries will need to emulate if they are to mitigate the credit risks and loss of demand inherent in the collapse of economic activity associated with the pandemic."

Expectations for a Chinese rebound have risen in tandem with signs that the infection rate in China has plateaued and industry starts to kick into life: flights are increasing again as are pollution levels, tell-tale signs of a recovery.

The expectation is that the recovery will be sharp, emulating a v-shape on a graph.

Some investors take a similar assumption for any recovery to Western economies: the virus will peak in coming weeks and the economies will roar back to where they were ahead of the outbreak.

Bloom says this assumption is however ultimately flawed simply because whereas China's economic base is in manufacturing and the Western economy is based on services. Manufacturers can overcome lost production by increasing production rates in coming months, but lost business in the service sector cannot simply be replaced.

"The car you didn't build, you build two, but if you didn't go the restaurant, you didn't take that airline flight, you are not going to take two the next month, so our economies in the West are service economies where 70% of the economies are service sector," says Bloom.

Service sector recoveries therefore are not likely to see a v-shaped recovery says Bloom, but the manufacturing sector can. "You get lost output on the service sector side and we are service sector economy."

Analysts at Danske Bank have briefed clients this week that they expect the coronavirus slump to persist longer than had been initially anticipated, with a rebound in growth only coming in the second half of the year.

Dispelling the notion that there would be a rapid v-shaped recovery, Piet P. H. Christiansen. Chief Strategist of ECB and Fixed Income at Danske Bank says, "COVID-19 is spreading into new regions, turning the economic outlook into a U-shaped recovery rather than a V-shaped one."

Danske Bank have have lowered their growth outlook for 2020 globally and expect slow global growth to extend well into the second quarter, before giving way to a recovery in the second half of the year as virus concerns abate.

"We do not expect an L-shaped scenario, where the global economy is stuck in recession throughout the year," adds Christiansen.

However, the assumption is built on a set of assumptions and should the outbreak evolve into something longer lasting and more severe, a long-lasting global recession might ensue.

"In a downside scenario where the virus outbreak turns out to be much more severe, the hit to economic growth will be more severe and prolonged, even with a coordinated and forceful monetary and fiscal policy response," says Christiansen.