Bank of Canada may cut rates to aid economy sickened by COVID-19: Don Pittis

It is becoming increasingly clear that the impact of COVID-19 on the economy is far more than a blip.

Economists' earlier hopes of a V-shaped recovery —  a sharp rise back to normal after a sharp decline — are fading fast as evidence increases that the global effects of the virus on consumers and businesses are widening.

But just as the Bank of Canada is chewing over whether to cut interest rates tomorrow, the Organization for Economic Co-operation and Development, sometimes described as the rich countries' economic think-tank, insisted yesterday that co-ordinated government action is essential to prevent a "worst-case scenario." And its prescription included lower rates.

Expect to see more co-ordinated planning today following a meeting of G7 finance ministers. In keeping with recommendations to avoid spreading the virus, the meeting is expected to be by conference call.

Return to health

And while a V-shaped recovery seems off the table, the OECD says acting to prevent serious financial damage will mean the economy has every chance of bouncing back to very close to expected levels within two years. It's a sign of the times that this counts as optimism.

As of yesterday, markets were predicting that the Bank of Canada would cut rates by at least one-quarter of a percentage point on Wednesday, with a smaller chance of a half-percentage-point cut.

A rate cut would be unusual but not unprecedented, since the bank is scheduled to make its policy statement with a written release only. In the normal course of events the bank tends to make rate changes on the occasions when the governor, Stephen Poloz, holds a media conference to explain his actions.

But this may well be a time when even the most staid central banker will err on the side of haste.

As well as plenty of pressure from investors for rate cuts as a measure to stop stock market declines, OECD chief economist Laurence Boone yesterday called on governments, including central banks, to act quickly to prevent damage to the wider economy.

In the past, markets have responded to rate cuts with a pop up in share prices, something traders would relish after seven long days of declines. But according to Boone, there is much more at stake.

In a new report titled Coronavirus: The world economy at risk the Paris-based think-tank laid out some worrying scenarios.

"The main question for the economic outlook is how long and how widely the virus will spread, and with it the containment measures," said Boone.

As others have said, the illness caused by the coronavirus is only the indirect cause of economic damage. Instead, it is the methods governments have used to prevent the spread of COVID-19 that have led to simultaneous supply and demand shocks to the economy.

On the supply side, a quarantined workforce means factories stop production, an effect that can spread around the world as unique parts become unavailable, leading to a shortage of some goods.

On the demand side, inactive factories mean they don't need things like aluminum and copper. Also, people who stay home to avoid the virus cut back on purchases like airline tickets, movies and restaurant meals.

Bad, worse and worst cases

If the effects were short term, the money not spent now would merely be spent later. But for central bank economists one of the concerns will be that a synchronized decline in supply and demand will mean the economy operates far below capacity. The value that should have been produced by that unused labour and capital is gone for good.

It is not a sure thing rate cuts will fix that problem. If someone does not want to borrow at all, it is not clear lower rates will convince them. Others have worried cuts at this stage, especially by the U.S. Federal Reserve Board, will mean it will be almost impossible to lift rates again during this U.S. election year.

But there may be worse things to worry about. As Boone described it, there were three scenarios in the OECD analysis, each gloomier than the next. Essentially the 0.5 per cent decline in global growth, which Boone described as "the base case," would occur if the impacts of the disease were largely limited to China.

But if COVID-19 and its resulting containment measures were to spread to most of Asia, to Europe and to North America, the decline in global growth would be closer to 1.5 per cent, cutting world growth in half. But that is still not the worst of it.

"I think what I should stress at this stage is that this is not a worst-case scenario," warned Boone.

There could be a much bleaker result if the wider coronavirus impact led to dangers such as damage to the financial system and a liquidity crisis, where corporate borrowers desperately search for cash and simply cannot find it.

To try to avoid the bleakest case, the OECD proposes that governments must be prepared to take co-ordinated action including such measures as helping ordinary people with health-care spending and cash, delaying tax demands on companies and supporting the broader financial system with increased bank liquidity, public investment and cuts in interest rates.

Boone called for a joint statement by governments on those actions that would reassure all the participants in the global economy, leading to a medium-term recovery.

"I think that would help, with two years, the recovery of nearly all the losses from the downside scenario," she said.

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