The eurozone’s 19 member countries are braced for a dramatic downturn. The head of the European Central Bank, Christine Lagarde, warned last week that the bloc’s collective GDP was likely to shrink by between 8% and 12% this year, having concluded that the ECB’s “medium” and “severe” scenarios were the only ones worth considering.
The economic consequences of coronavirus are dire already, with France and Italy in recession. France’s GDP contracted by 5.8% in the first quarter of 2020, following a decline of 0.1% in the preceding three months. Italy saw its GDP fall by 4.7% in the first quarter of 2020, in the wake of a 0.3% decline in late 2019. As a whole, eurozone GDP decreased by 3.8% in the first three months of 2020 – the sharpest quarterly decline since records began in 1995.
The betting is that Lagarde and the rest of the ECB board will use this week’s meeting to expand its €750bn Pandemic Emergency Purchase Programme (PEPP). For many ECB-watchers, this will show how important the PEPP has been during lockdown and offer proof, if that were needed, that states are struggling to revive their economies.
The programme, which lets the ECB fund private companies and government budgets by purchasing corporate debt and sovereign bonds, will probably increase to €1 trillion and could eventually reach €1.5tn.
Lagarde has repeated the mantra of her predecessor, Mario Draghi: the ECB will do whatever it takes to keep the eurozone economies afloat. This should reassure businesses and consumers that any financial wobbles, wherever they crop up inside the eurozone, will be confronted by the ECB’s limitless supply of funds.
But there is increasing nervousness in Italy and Spain, where the ECB plays a crucial funding role, that a recent German constitutional court ruling could circumscribe the ECB’s power. This month, Germany’s federal constitutional court set aside a 2018 European court of justice (ECJ) ruling and questioned the legality of ECB asset purchases. The German judges said the ECB had overstepped its mandate with the programme, which in turn prompted the ECJ to issue a polite reminder that it alone has the power to decide whether EU bodies are breaching the bloc’s rules. It had ruled in 2018 that such a bond-buying programme was legal. And thus battle lines between Brussels and Berlin have been drawn.
Speaking this month, an EU official said: “This raises a couple of fundamental issues … first is the authority of a judgment of the European court of justice which has definitely ruled on the validity of the decisions of the ECB. This goes to the very basis of the European Union. The European Union is based on law, on agreement, on the common rules we have.”
Lagarde needs to quickly address the court’s concerns, or risk the bailout programme grinding to a halt. But she will need backing. The political and economic threat of not resolving the row could be seismic, and the help of the European commission president, Ursula von der Leyen, and the German chancellor, Angela Merkel, will be required. Merkel, the leader of the eurozone’s most powerful economy, has said that a clash between Brussels and Germany can be avoided if, as per the German court ruling, the ECB illustrates the necessity of its bond-buying scheme.
If the standoff is not resolved and the ECB’s rescue programme is stymied, then the eurozone’s recession will deepen and political and economic fault lines in the EU will widen. A lot is at stake at this week’s meeting, and Lagarde needs the EU and Germany to square their differences.
Sunak must go further on furlough
The chancellor has clearly listened to demands that his main employment subsidy scheme should be scaled down gradually. A cliff-edge that loomed in August for the 8.4 million workers furloughed since April has become a gentler slope, although there are still huge risks ahead for Rishi Sunak, Britain’s 32 million workers and the economy’s prospects of emerging from the crisis relatively unscathed.
The Coronavirus Job Retention Scheme currently pays 80% of a worker’s salary up to a cap of £2,500 a month. Until last week, the chancellor was going to change the terms so that employers received only 60% of a worker’s wages from 1 August. This would have been a huge cost to tens of thousands of shuttered businesses. Sunak has noted this. From August, employers will only need to find the money for employers’ national insurance and pension payments for furloughed staff.
Then comes the slope: from 1 September the government will pay 70% of wages. During October it will be 60%. Self-employed workers will receive a matching grant worth 70% of their average monthly trading profits to cover three months from August.
Nonetheless, there is a missing element from Sunak’s plans. There are industries that will receive very little or no income from paying customers from now until October and beyond. What is the chancellor going to do to rescue Britain’s mighty tourism industry, its leisure centres, gyms, hotels, bars and nightclubs? Physical distancing will limit their recovery until, or if, a vaccine arrives.
They should be candidates for further support after October. It would be tragic if the UK reduced subsidies before businesses can stand unaided, triggering a jump in bankruptcies and unemployment that would undermine the good work of recent months.
Rolls-Royce’s plight signals importance of state support
Rolls-Royce has been hit hard by the coronavirus crisis. Credit ratings agency Standard & Poor’s piled on the pain for the manufacturer last week, marking down its debt – after 20 years at investment grade – to junk status.
While its defence business – making parts for fighter jet and nuclear submarine engines – is largely unaffected, the group’s civil aerospace operation has stuttered alongside the grounded airlines to which it sells engines and servicing contracts. The planned cutting of 9,000 jobs, the bulk of them at UK sites including its Derby base, are a major blow to British engineering.
The rating downgrade could have material implications. Many institutional investors are, understandably, banned from buying junk bonds, so S&P’s move could make it more costly for Rolls-Royce to borrow if costs continue to mount.
It is also striking that the downgrade came after swingeing cost cuts and Rolls-Royce’s professed willingness to ask for government support. The company, one of the few true global players left in UK manufacturing and a key part of UK defence plans, will be helped if needed; the shadow business secretary, Ed Miliband, has signalled that he would back support. Rolls-Royce’s stock of goodwill with government has also been aided by its involvement in Ventilator Challenge UK, the effort to build machines to treat Covid-19 patients.
The financial crisis a decade ago showed that ratings agencies are often more weather vane than fortune teller, but when it comes to crunch time for companies, their views are still important. The junking of Rolls-Royce’s rating shows that investors may not be reliable providers of help for the struggling aerospace sector.
S&P warned that Rolls-Royce could be exposed to further losses as the pandemic drags on. If things are this bad for Rolls-Royce, smaller companies, whose size does not warrant a rating agency’s attentions, will be under much greater pressure.