Coronavirus update: 2 minutes on banks and inflation

May 14 2020

Jim McCormickGlobal Head of Desk Strategy

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Short on time? Jim McCormick shortlists the key points around why today’s healthy banking system could mean a promising outlook for the coronavirus crisis recovery. 

In this crisis, banks are part of the solution — not the problem

Two themes that were front and centre in the past few weeks  were the banking sector and inflation. One thing I have said since the start of this crisis is the relative healthiness of banks is a key difference today compared with the 2008 Global Financial Crisis and 2011/12 Eurozone debt crisis.

In these last two crises, banks were a big part of the problem. They were ill-prepared and undercapitalised and were a key blockage to any recovery. Today, banks are much healthier and policymakers are looking to the banking system to be part of the solution. Both of these factors have been on display recently.

With healthy banks an economic recovery is more likely to take hold

The European Union’s latest financial package should provide significant relief to banks from a capital perspective. Encouragingly, both actual Euro Area bank lending and bank lending intentions suggest banks are prepared to provide credit despite the very difficult economic conditions.

Beyond what this means for bank assets (it is good), the healthiness of banks provides a stronger case for the economic recovery to eventually take hold.      

Healthy banks also make a stronger case for upside risks to inflation

While higher food prices helped boost April inflation in Australia, the Euro Area and to a lesser degree the US, the near-term outlook for inflation remains bearish. Further out, the picture is less clear, although I’d suggest there are three clear reasons not to be complacent about upside risks.

Three clear reasons not to be complacent about inflation upside risk

  • The first is the size of the policy response. It is massive, and will not be unwound quickly.
  • The second is the potential size of the supply shock. The impact of the crisis on globalisation, localisation of supply chains and possibly even basic supply issues for the likes of air travel and restaurants could be huge.
  • A third inflation risk is the banking sector. In the wake massive monetary policy response after the 2008 Global Financial Crisis, many called for a surge in inflation. It didn’t happen. While there are probably many reasons for this, the blockage in the banking system likely played a big part. This is far less of a problem today.
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