Bank of America Global Research | The balance of risks to our Euro area growth forecast was tilted to the downside already amid Brexit uncertainty, US-China and US-EU trade tensions and the fragility of domestic demand resilience. The Coronavirus is now a new shock. We lower our Euro area growth forecast to 0.6% for 2020 (-40bp), on the back of lower foreign demand (global growth downgraded to 2.8%, from 3.1%), supply chain disruptions and at least temporarily lower domestic demand from local virus hot-spots. We keep our 2021 forecast unchanged at 1.1%, assuming a permanent loss in activity. Euro area growth is expected be close to zero in 1H20 (with negative quarters in Italy and Germany part of our base case). 2Q GDP growth (late 1Q, early 2Q monthly data) will be more impacted, before growth resumes in 2H again including a small bounce-back towards year-end, in our view. Our forecasts remain subject to downside risks; they require improving external demand, no large disruptions in Europe and resolution by late spring, so that tourism distortions fade by the summer.
Some small help from fiscal policy
We assume that 2H growth will be supported by some small-scale fiscal easing. We would expect countries to make full use of the standard escape clause enshrined in European rules that will provide some modest support. In the particular case of Germany we think a front-loading of the partial solidarity surcharge abolition to mid-year (from Jan-21) is now very likely. Our assumption on the fiscal modus operandi, therefore, remains: further deterioration first, partial and late repair second. Neither fiscal nor monetary easing can probably avoid 1H weakness, which is (to a very large extent) supply side-driven. But it can facilitate a quicker return to demand growth when disruptions fade and hence try to limit the permanent damage to activity levels. A stronger fiscal response would catch us as an “upward” surprise and could strengthen the very small and partial bounce-back in 4Q20.
The ECB probably cannot be ‘the game in town’
Markets are pricing a 10bp depo rate cut – we still think the bar for this is high. At EURUSD around 1.08 in spite of three Fed cuts being priced and increasing ECB talk of “side effects”, we find another depo rate cut counter-intuitive. The “automatic stabiliser” embedded in forward guidance means low rates for even longer, and that may make corrective action to avoid negative effects of negative deposit rates on bank lending even more necessary – we stick to our call for more generous tiering in 2H20. We cannot rule out the ECB reacting with a small increase in monthly purchases to EUR30bn by the summer (mostly through more private sector purchases), if disruptions go beyond our expectations. But even that, we think, should not be the base case at this juncture.
It goes beyond Europe
This is part of a global revision. We forecast 1Q global growth of less than 1% qoq saar and we cut full year growth from 3.1% to 2.8%. The forecast assumes China gradually returns to work in the coming weeks and there are sporadic outbreaks outside China, triggering strong quarantining measures and further pressure on confidence. Despite a second half recovery, there will be some permanent damage.