The OECD’s analysis of the impact of the coronavirus on the world economy published last week sets out two scenarios. In the base case, the epidemic peaks in China in quarter one and the outbreaks elsewhere prove mild and contained.
Nonetheless, supply chains are interrupted and demand weakens, with the tourism and travel sectors most impacted.
Under this scenario, GDP growth is forecast at 2.4% for the global economy in 2020, down from 2.9% previously. The world economy regains momentum as the virus fades, with the OECD raising its growth forecast for next year from 3% to 3.3%, helped also by policy loosening.
In the second more adverse scenario, there is a longer-lasting and more intensive coronavirus outbreak that spreads throughout the world.
There is a significant hit to global demand with the peak of the shock occurring in the second half of this year, before gradually fading away by early 2021.
In this scenario, the projected growth rate of the world economy in 2020 is halved to 1.5%.
This would imply that output falls for two to three quarters and many major economies enter recession, such as the Eurozone, UK and Japan and possibly the US.
While economic activity is expected to regain momentum next year, the average growth for 2021 is likely to be low. The OECD did not publish individual country forecasts for this scenario.
By our calculations, GDP growth could average around 0.5% next year in many advanced economies.
It would seem that financial markets expect a coronavirus impact that resembles the adverse OECD scenario rather than its base case. Central banks have already started to cut interest rates and further significant policy easing is expected in the coming weeks.
The US Federal Reserve cut rates by 50bps to 1.125% in an emergency move last week. Futures contracts are pricing in a further 100bps of loosening by the summer, taking rates down to the previous low during the financial crisis of 0.125%.
The Bank of England is expected to cut rates by over 60bps to a new record low of 0.125%.
There are 30bps rate reductions priced in for the European Central Bank and the Bank of Japan – this would take the ECB deposit rate down to -0.8%.
The anticipated easing of monetary policy is not a surprise given the extent of the shock that is likely to the world economy this year, as well as the current turmoil in financial markets.
Most notably, though, markets do not expect central banks to start reversing the policy easing for a considerable period of time.
It is anticipated that Fed rates will have risen by just 25bps to 0.375% by 2025. In the UK, rates are expected to remain at 0.125% well into the second half of the coming decade.
Meanwhile, there is no end in sight for deeply negative interest rates in the Eurozone.
Indeed, the yield on 30 year German bonds fell to -0.5% yesterday, which would suggest a very prolonged period of negative rates.
Futures contacts, then, appear to be taking a very downbeat view of economic activity for years to come. The coronavirus will certainly depress economic growth this year.
However, the expert opinion is that the virus will have abated by end 2020. Thus, economic activity should rebound next year.
The focus for markets right now, though, is very much on the shock to activity from the virus, not the subsequent rebound. Thus, they can be expected to remain weak and volatile for the next few months.