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Central banks may mount a coronavirus rescue. It may not be enough

[February 29, 2020] By Howard Schneider, Leika Kihara and Francesco Canepa

(Reuters) - Cratering markets are pushing global central banks to the point they all warned against and worried about, of an evolving global economic shock hitting at a time when their capacity to respond in force is in doubt even as investors hound them for action.

Buffeted by a global trade war, monetary policymakers were already spending down their "ammunition" to keep a sluggish world economy from slipping further, only to now face a new and unexpected blow from the rapidly spreading coronavirus that has sowed fear worldwide.

On Friday afternoon, Federal Reserve Chair Jerome Powell issued a statement in which he said that while the U.S. economy remained strong, the virus 'posed an evolving risk' and the Fed stood ready to take action if needed.

"The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy," Powell said.

Powell's comments came after days of central bankers around the globe emphasizing a wait-and-see approach, causing some head-scratching among analysts who thought the Fed needed to say something to soothe markets.

"The Fed has bungled its message on the virus, has confused markets, and has painted itself into an untenable corner," Cornerstone Macro economist Roberto Perli said in a note earlier on Friday. "Unless the virus is contained quickly, rate cuts in March (if not sooner) and beyond are a base case, regardless of recent comments by various officials."

U.S. stocks pared losses slightly after Powell's comments, but the S&P 500 index <.SPX> still closed lower for a seventh straight day.

HOW MUCH AMMUNITION?

How much central banks can do remains the central question.

The Federal Reserve's interest rates are already at low levels, trimmed three times last year as the Trump administration roiled markets in a trade battle with China. The European Central Bank and the Bank of Japan, with interest rates below zero, may particularly struggle for a response effective against the type of trouble stemming from the coronavirus.

Monetary policy is most potent in bolstering demand by lowering the cost of borrowing - it cannot restore global supply chains that have ground to a halt or convince people it is safe to go on a trip or for businesses to hold a sales convention.

Still, monetary policymakers worldwide have braced to act even while arguing - perhaps hoping - for a base case in which the virus is contained reasonably soon. Markets may have fallen off a cliff, they note; the real economy has not.

Goushi Kataoka, one of the most dovish members of the BOJ's nine-member board, said he saw no immediate need to take monetary policy action in response to the virus outbreak.

"I don't think the BOJ needs to take additional monetary easing steps now in response to the coronavirus outbreak. We need to first look at how serious the impact from the outbreak would be," Kataoka told a news conference on Thursday.

Central bankers in recent years have warned broadly that their "toolkit" is limited by globally low interest rates and lingering doubts that bond buying and other strategies will prove effective in another sharp downturn. They have more openly urged fiscal authorities to plan for a fuller use of the government's taxing and spending powers to shoulder the burden of crisis response.

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The Federal Reserve building is pictured in Washington, DC, U.S., August 22, 2018. REUTERS/Chris Wattie/File Photo/File Photo

To some extent, authorities were taking fiscal action. Officials in Europe were moving to ease business credit and lower taxes with temporary measures, and U.S. President Donald Trump's administration was being pressured by congressional leaders to lay out more explicitly any fiscal steps it might take to bolster the economy.

RATE CUTS ON THE RADAR

Still, whatever the scope for fiscal policy, investors seemed to think events are forcing monetary authorities toward some sort of response even if their firepower is limited.

A Fed rate cut at the upcoming March 17-18 meeting is now seen as a near certainty, with some analysts expecting aggressive action and perhaps even an emergency step in the interim. Some market pricing showed the Fed hitting the zero bound again this year.

"We anticipate that the Fed will cut rates by at least 50 basis points over the coming months, with our new baseline forecast expecting 25 basis point cuts at the next two meetings in March and April," Deutsche Bank economists said in a note on Friday.

Central banks have made clear they will be cautious.

St. Louis Federal Reserve president James Bullard on Friday said he was open to cutting interest rates "if the situation gets worse and there looks like there will be a major effect on the U.S. economy...But we would have to get to that juncture."

There was a similar show of unity among policymakers globally, with officials in Canada, Europe, Japan, Switzerland and elsewhere saying they stood ready to act if the virus remains uncontained.

The Bank of Canada may show itself to be the first out of the gate with a response as it convenes a policy meeting next week. Economists polled by Reuters see no change in rates from the BOC, but money markets are now pricing a quarter point cut.

The underlying forecast for policymakers globally is that the coronavirus would follow its course as have other viral outbreaks without bringing the world economy to a full stop.

Bullard put his own parameters around that: seasonal flu kills hundreds of thousands annually, he noted, compared with a few thousand fatalities so far from COVID-19, suggesting investor fear may be running ahead of the facts and creating a baseline he intends to watch in assessing any rate cut.

European policymakers have said they also believe it is too early to say whether a central bank response is appropriate.

"This is a very complex monetary policy issue which, in my view, does not require acute monetary policy action," Bundesbank President Jens Weidmann said on Friday.

(Reporting by Howard Schneider in Fort Smith, Arkansas; Steve Scherer in Ottawa; Francesco Canepa in Frankfurt; Michael Nienaber in Berlin; Leika Kihara in Toyko; Editing by Dan Burns and Andrea Ricci)

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