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●   Falling inflation expectations: The hit to global economic activity in the coming months will likely exceed the initial damage from the great financial crisis. Ever more restrictive social distancing policies across the world to manage the spread of coronavirus are crippling global demand and supply. In the US, the Eurozone and the UK, inflation expectations are falling sharply, to rates well below central banks’ 2% targets – see chart.

●   The silver lining: During an economic crisis, the only real constraint on policymakers’ ability to act is inflation. As long as inflation expectations remain well anchored, or are falling, governments and central banks can act as aggressively as needed to contain the risks and promote confidence. Amid the huge shock to economic activity, which will push up unemployment and dampen wage pressure, policymakers need not fear that their massive coordinated monetary and fiscal stimulus could turn into run-away inflation any time soon.

●   The role of central banks: The governments of advanced economies are raising an unprecedented amount of cash in the open market to fund their immense coronavirus support packages. Two conditions need to be met to make this possible: 1) long-term inflation expectations must remain well anchored; and 2) government debt markets have to remain liquid. This is where the central bank comes in. As long as potential creditors remain confident that their cash will retain its value while the government has it and that, if they want to sell their bonds, they just have to form an orderly queue outside the central bank, fiscal policymakers will face no problems raising the funds they need.

●   Even more bond buying to come? Yes, perhaps. It partly depends upon how much debt governments run up. We expect major central banks to hoover up most or all of the extra debt their governments accumulate to tackle the coronavirus hit in order to keep benchmark borrowing costs favourable. Whereas the asset purchases announced by major central banks so far sound big, the debt issuance to come could be bigger still. For example, while the Bank of England announced £200bn in asset purchases yesterday, the UK government could easily run up a debt of 20% of GDP (c£45obn) in the months to come. This logic applies elsewhere. Central banks, including the European Central Bank, which has announced asset purchases of €1.1trn this year, and the US Federal Reserve ($700bn so far), may need to buy even more bonds.

●   Beyond coronavirus: The boost from the combined fiscal/monetary stimulus will far outlast the immediate economic damage of the virus and the measures in place to contain it. While the drop in economic activity in the coming months will be spectacular, the rebound could be almost equally as impressive, although it will likely be staggered as the lockdowns may be eased in stages. That the aggressive current policy responses could fuel an inflationary consumption boom in the foreseeable future seems unlikely. The same applies to a hypothetical risk of surging wage inflation in the wake of a situation in which unemployment could be materially higher for a while. Still, when the rebound comes, expect a degree of symmetry in economic policy. Some of the measures taken now to support economies could be reversed once the rebound is underway to stabilise the upswing.

Holger Schmieding

Chief Economist

+44 20 3207 7889

[email protected]

Kallum Pickering

Senior Economist

+44 20 3465 2672

[email protected]

Florian Hense

European Economist

+4420 3207 7859

[email protected]

Disclosures

This material is intended as commentary on political, economic or market conditions for institutional investors or market professionals only and does not constitute a financial analysis or a research report as defined by applicable regulation. See the "Disclaimers" section of this report.

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