Italy, the Eurozone and the EUR. There are Tougher Times Ahead…

Just a few weeks ago, EU member states held an emergency meeting to discuss the coronavirus and how to handle the spread.

A decision to leave borders open had provided support to riskier assets at the time. As the markets and member states are learning the hard way, leaving borders open and failing to incorporate containment measures will leave the world’s largest economies to pay the price.

China’s blueprint should have sent a global message, yet the Italian government waited until the 2^nd week of March and the number cases to surge through to 7,000 and more before quarantining an entire region of the country.

Needless to say, the damage has been done, not just for Italy but for the EU and beyond. A 2-week incubation period that could be longer may well see a super spread across the west.

The Italian Government Response

Not only has the Italian government quarantined 16m, with more likely to experience a prolonged shut-down, but the government has also promised economic stimulus to counter the impact of the virus.

Ironically, the economy had been facing a recession before the coronavirus reached Italy, with the U.S – China trade war taking its toll.

As the region’s 2^nd largest manufacturer, a lockdown of the industrial north is going to be a disaster for the economy. Even more so when you consider the impact of the virus on tourism…

Whatever happens, the government will inevitably breach EU rules by a far largest extent.

The bad news is that the government will seize the opportunity to loosen the purse strings. They had faced the wrath of Brussels before and that was before the economy was facing the prospect of a material slowdown.

Public debt sits well above 100% of GDP and that’s before any increased spending. The government’s promise of returning the country to within the EU’s restrictions will be of little consolation.

After all, the restriction is actually government debt to GDP of 60%. Italy has been nowhere near that in recent memory.

For the Italian government, it was the perfect time to stretch the envelope. EU member states would have accused the Establishment of failing Italy and the region. That’s before considering the fallout from voters…

So, no surprise that EU member states were given the freedom to breach the Stability and Growth pact last week.

The Eurozone and the EUR

While Italy looks to splurge, there will be a price to pay down the road.

If you take Greece as a recent model, there is a very long road back from an economic meltdown. The government may spend more, but with quarantines, productivity is going to tumble and it’s going to take some time to recover.

After all, it is not just domestic demand but also global demand that would need to support a sharp rebound.

If the virus continues to spread, rating downgrades could be next. Imagine if Germany also succumbs to the virus, along with the U.S…

For the EUR, the swift move to stem the near-term effect of the coronavirus on the economy has been positive. Fiscal support could even alleviate pressure on the ECB to deliver on Thursday… It would be optically another story, however, should the ECB stand pat.

There’s a long way to go before the spread of the coronavirus abates and the effects are reversed. The Dollar has borne the brunt of the spread west in recent weeks. Don’t expect fiscal policy support alone to be good enough for the EUR…

At the time of writing, the EUR was up by 1.31% to $1.1433.

The biggest concern is the size of the response by governments and central banks. Few if any can foresee when the spread of the virus will ease and what actual impact there will be. Not just on economies, but on human life…

Throwing in the kitchen sink at this juncture may be the biggest mistake of all.