News Review: Economics
Glacial eurozone resolution will hurt UK by
Fionnuala Earley,
UK consumer economist, Royal Bank of Scotland
French President nicholas Sarkozy may be sick of British Prime minister david cameron’s insistence on involvement in decisions on the future of the euro but, given the importance of the currency to the uK’s economic future, you can hardly blame the Prime minister for wanting a say. the uK’s economic
recovery depends on a pickup in demand in europe – our major trading partner. But persistent worries about sovereign debt defaults in the weaker economies affects confidence in the whole of the eurozone and holds back the pace of recovery. this puts the uK’s recovery at risk too. and the longer the uncertainty goes on, the more of a vicious circle it becomes as sovereign debt downgrades by ratings agencies begin to affect the banking system.
QE2 highlights threat the gravity of the eurozone crisis for the uK economy couldn’t have been made any more plain by the monetary Policy committee. its decision to increase the size of the asset purchase facility, quantitative easing, at a time when uK inflation reached more than two and a half times its target and its highest rate since the early 1990s, highlighted just how serious the mPc thinks the situation is. While we knew more Qe
was on the cards from the language in the minutes of earlier meetings, the choice to act in october, outside of the inflation report cycle, was a surprise. So too was the size of the increase: £75bn rather than the more widely expected £50bn, with the potential for some more too. the governor’s language in recent speeches also signalled his depth of concern and the need for a concerted and co-ordinated approach to rebalance, not just the eurozone, but the global economy.
Glacial decision making european leaders have been struggling to agree a lasting solution to the eurozone crisis, but the longer this takes, the worse things get, as markets wonder whether a solution will ever be found. in the last few weeks, italy’s and Spain’s sovereign debts have been downgraded and a Franco- Belgian bank has had to be bailed out. the longer it takes to find a solution, the greater the uncertainty of ever finding one becomes, and the greater the risk that the european, and even global, banking system will be affected. the issues that need
to be resolved include a reduction in the greek debt burden, support for the european banking system and the prevention of further contagion to other member states. the point of stalemate is how to maximise the €440bn european Financial Stability Fund’s firepower. French proposals include turning the fund into a bank, which could borrow
20 mortgage introducer NOVEMBER 2011
from the european central Bank. this plan increases the level of direct support the French government can provide without jeopardising the credibility of its own public
finances and
hopefully heading off further downgrades which infect the banking system. But germany is reluctant to commit to this plan. it wants investors to take some of the pain and accept a “haircut” or smaller than contractual repayment. and you can see their point too – why should the richer countries take the whole hit of bailing out governments which haven’t played by the rules?
UK impact Whichever argument you have sympathy with, the failure of French and german policymakers to find common ground increases the risk that they lose what little control of events they still have. But what does this mean for the uK? in the short term, the uK has relatively little exposure to the banking systems in the weaker eurozone countries
- only about 12% of the total eurozone banking exposures - but there isn’t room for complacency. the uK has much higher
exposures to French and german banks. if these are infected by uncertainties about solvency resulting from sovereign debt problems in the weaker economies, uK banks will begin to suffer too. and the more uncertainty there is about solvency, the less liquid markets become and the more difficult it is to fund day-to-day lending.
Housing market the eurozone sovereign debt problems, combined with the marked slowing in the world economy, have lengthened the period over which a return to normality is likely and this also has the potential to seriously affect the uK housing market. although unemployment has been broadly stable for over two years, it has begun to creep up. a lack of confidence about the pace of future recovery will threaten not only the creation of new jobs, but also existing ones.
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