Coronavirus: ECB warns eurozone economy could shrink by 12% as it expands loans to banks

Edmund Heaphy
Finance and news reporter

The European Central Bank warned on Thursday that the eurozone’s economy could shrink by as much as 12% this year due to the coronavirus pandemic, noting that the extent of the imminent recession in the bloc was “difficult to predict.”

Analysis conducted by the bank suggests that the bloc’s gross domestic product (GDP) will fall by between 5% and 12% in 2020, ECB president Christine Lagarde said.

“We are facing an economic contraction of a magnitude and speed that is unprecedented in recent history,” she said, noting that how long the recession and recovery would last depends on the duration and success of virus containment measures and the subsequent policy response.

“The spread of the coronavirus and the associated containment measures have literally halted economic activity to a large extent across the globe,” Lagarde said.

Her comments came after the central bank said it would lower interest rates on a facility that provides cheap loans to eurozone banks, and after it introduced a new facility to provide an effective liquidity backstop to the bloc.

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The minimum interest rates charged on loans offered as part of its targeted longer-term refinancing operations — know as TLTROs — will now be 50 basis points below the average interest rate on the bank’s main refinancing operations, meaning that banks will be able to borrow more cheaply.

This decision to lower the minimum interest rate is “absolutely massive”, said Frederik Ducrozet, a senior economist at Pictet Wealth Management.

“This will result in a net transfer of up to €3bn to the banking sector while ensuring the financing of the real economy,” he said.

The bank also introduced a series of “non-targeted” refinancing operations, which could allow eurozone banks to buy government bonds using extremely cheap ECB loans.

Though the loans will mature by the end of September 2021, the move could raise concerns about banks taking on sovereign credit risks, which caused a so-called “doom loop” after the 2008 financial crisis.

The bank left its headline interest rates unchanged and did not increase the size of its bond-buying programmes, but signaled that it would continue its current pace of purchases and would expand them if it needed.

The bank has purchased around €150bn (£131bn) in eurozone bonds in the six weeks since it launched its coronavirus bond-buying programme, which is designed to curb the borrowing costs of badly hit countries like Italy and Spain.

At its last scheduled meeting on 12 March, the central bank expanded its existing asset-purchasing programme, giving it room to purchase an additional €120bn in bonds in 2020.

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But the bank has already used a significant chunk of that additional firepower, and the pace of purchases under the newer emergency programme — announced a week later — suggests the bank will run out of headroom at the end of October, according to analysts at Nomura.

While the markedly elevated bond purchases initially pushed borrowing costs lower, bond yields have risen in recent weeks, and the ECB has been more cautious than other central banks.

Unlike the US Federal Reserve and the Bank of England, the ECB is legally prohibited from directly financing the deficits of eurozone governments.

But the bank has chosen to relax or even abandon several self-imposed constraints on bond purchases, such as a limit on the proportion of bonds it can buy from a particular eurozone country.