Eurozone recovery to take three years, warns ECB’s chief economist

The European Central Bank’s chief economist has warned it is likely to take at least three years for the eurozone economy to fully recover from the “extraordinary and severe shock” of the coronavirus crisis.

Philip Lane said that under the “severe” scenario modelled by the ECB — entailing a 12 per cent decline in eurozone gross domestic product this year — the economy would not still return to its level at the end of last year before 2023. 

A chart published by the ECB indicated that the same outcome would occur under its “medium” scenario that entails an 8 per cent economic contraction this year. Only under its “mild” scenario of a 5 per cent economic shrinkage this year would the eurozone fully rebound by the middle of next year.

“The scale and duration of the pandemic macroeconomic shock depends on how long the lockdown measures remain in place, their impact across sectors and the speed at which economic activity normalises,” Mr Lane wrote in a blog published on Friday.

The eurozone economy shrank by a record quarterly rate of 3.8 per cent in the first three months of this year, figures published on Thursday showed. Most economists expect the decline to be much steeper in the April to June period because the strict lockdowns that have frozen much economic activity were only introduced in March.

The ECB on Thursday kept its main deposit rate unchanged at minus 0.5 per cent, while lowering funding costs for banks by slashing the rate at which it will lend them money to a record low of minus 1 per cent — in effect paying them to borrow money.

On Friday Mr Lane gave the clearest indication yet that the ECB was preparing to increase the scale and timeframe of asset purchases under the €750bn pandemic emergency purchase programme (PEPP), which it launched in March as the centrepiece of its coronavirus response.

He said it would “continuously examine” all of its measures to ensure they were sufficient, adding: “We will further adjust our instruments if warranted. This includes increasing the size of the PEPP and adjusting its composition as much as necessary and for as long as needed.”

Mr Lane, who moved from running the Irish central bank to join the ECB last year, called on EU governments to step up their joint fiscal efforts — which would take some of the pressure off the central bank.

“Additional, bold and sustained policy action remains essential to guard against downside risks and support the recovery,” he said. 

He also sought to reassure investors about the ECB’s determination to prevent a sell-off in the debt of those European countries hit hardest by the crisis, such as Italy and Spain. Some investors doubted this commitment after ECB president Christine Lagarde said last month that it was not its role to “close the spread” in sovereign debt markets — referring to the gap between Italian and German bond yields that was a key risk indicator for Italy. 

The ECB chief economist said the central bank had “an additional market stabilisation role” given its position as the central bank for 19 countries inside a monetary union. This role was to counter any “self-fulfilling flight-to-safety dynamics and illiquidity in individual sovereign bond markets” that might arise in a crisis, reflecting “the high substitutability across sovereign bond markets in the absence of currency risk”.

“Such non-fundamental volatility in spreads impairs the smooth transmission of monetary policy across countries and it is a basic task for the central bank to counter such destabilising forces,” he added.