Eurozone Watch – Growth and inflation outlook will spur the ECB to do more

The eurozone economy has tumbled into a deep recession due to the spreading of the Covid-19 virus.The lockdowns throughout the region are resulting in dramatic drops in consumer spending and production in large parts of the economy.The abrupt (and unique) nature of the disruptions in economic activity implies that every extra week of lockdown reduces annual GDP growth in 2020 by roughly 0.75 percentage points …. … and also implies that growth will sharply rebound after the end of the lockdown. However, we think that the negative side effects via unemployment, defaults, tightening financial conditions and supply-side disruptions will push the eurozone economy back into recession after this initial rebound. Moreover, these negative second round effects are non-linear and become stronger, the longer the lockdown lasts. We expect the ongoing weakness in activity to reduce underlying inflationary pressures and result in a further decline in (core) inflation, which has already been undershooting the ECB target for a number of years. Government finances will deteriorate dramatically due to discretionary policy stimulus and the cyclical economic deterioration, leading to additional funding needs of EUR 690bn.We expect the ECB to step up the PEPP by EUR 500bn to 1250bn soon.