A second Greek election called, accelerating deposit withdrawals from Greek banks and a hardline stance from the rest of the eurozone. The past week has raised the probability of Greece’s exit from the euro from remote through possible towards likely. Britain has already been affected by the eurozone crisis. But what would happen were Greece to leave the single currency?
There is no doubt the impact would be bad – at least in the short run – even if the longer-run effect of break-up is less clear cut, writes Chris Giles . For the UK, the short-run hits would probably include lower exports to Greece and other eurozone countries, weaker asset prices, a rise in sterling compared with the current eurozone average, a direct hit to financial sector output, a new credit crunch and a drop in confidence.
Capital Economics has dared estimate the “total possible impact” of these events would knock 3.5 per cent from UK output over two years. But Vicky Redwood, at Capital, says “the eurozone situation could easily turn out worse than we have assumed”.
How much worse? The answer is potentially a lot. In the 2008-09 crash, UK output fell 7 per cent, not because bank lending dried up, but because so much spending suddenly stopped in an international panic. If that happens again, it really is something to fear.
The direct hit to UK banks and other City institutions caused by a Greek exit should not be disastrous in isolation, writes Sharlene Goff.
British lenders have been rapidly winding down their exposures to Greek debt and increasing their provisions against risky loans. They are left with just over £1bn of the country’s government bonds, equivalent to just 0.5 per cent of their high-quality capital and less than 0.1 per cent of UK gross domestic product, according to Capital Economics. UK banks’ exposures to Greek banks are even smaller, at about £630m.
However, economists and analysts fear the much harsher potential indirect effects. UK banks are highly exposed to their French rivals, for example, which in turn have much greater exposures to Greece.
A Greek exit would heighten fears that larger eurozone countries such as Spain and Italy, to which UK institutions are more closely connected, could be at risk of losing the euro.
Having to make severe writedowns on other European debt could cause big problems for UK banks, prompting renewed fears over their profitability and a rise in already inflated funding costs, leading to a lending freeze.
Analysts at Citigroup, the US bank, have estimated that the European Central Bank would have to deploy up to an additional €800bn in liquidity to mitigate a run on eurozone banks and to help them refinance their debt in the event of a Greek exit.
The broader concern for the City is a sharp fall in confidence. Markets are easily spooked and further disruption is likely to see businesses pulling back on investment and borrowing. That might exacerbate the severe shortage of small business lending and trigger more job cuts in Britain’s financial sector.
Companies are braced for a possibly sharp drop in demand if a Greek exit from the eurozone – destination for around half of UK exports – hits confidence, writes Brian Groom.
“There could be a direct impact on exports and potentially a hit to confidence which would affect consumption decisions in the UK, and also business investment,” said Robert Parkes, equity strategist at HSBC.
Lee Hopley, chief economist at the EEF manufacturers’ association, said there were so many variables that “the extent to which companies can try to model different scenarios is extremely difficult, and I think it is questionable whether economists have really got the tools to do that”.
If demand plummeted as in 2008, she said, companies were likely to respond similarly. Then, businesses cut working hours and froze pay, which helped save jobs.
Ms Hopley said companies had become “a lot more agile” after coping with shocks, including the financial crisis and supply chain disruption from the Japanese earthquake.
Much of the corporate sector is cash-rich, having rebuilt balance sheets. But a credit freeze could deprive smaller companies of working capital. Business investment, already looking flat, could take a further hit.
Mark Thomas at PA Consulting Group, said companies were poorly prepared, but if they planned there would be opportunities for smarter ones to increase market share. Those with cash could acquire assets cheaply or attack a weakened rival.
Savers approaching retirement have been told to expect reduced income from their pensions if Greece leaves the euro, write Elaine Moore and Tanya Powley. Pension funds are likely to be affected by the ensuing market volatility, which could boost investor interest in “safe-haven” assets, including gilts. Higher demand for gilts is likely to lower their yields, used by insurance companies to calculate income offered in annuities.
“Annuities are already at a record low and they could fall further,” said Billy Burrows, director with the Better Retirement Group. “We are advising people to fix their pension income as soon as possible.”
Homeowners also face a squeeze after the Bank of England said on Wednesday that British banks were likely to pass on “elevated funding costs” caused by the eurozone crisis. More than a million homeowners have already seen mortgage payments increase this month after several high-street lenders raised rates.
Holidaymakers may benefit from the euro’s drop in value against the pound, but those with second homes in Europe and anyone who has retired to the continent could see the sterling value of their property under threat.
George Osborne’s economic strategy is predicated on Britain exporting its way out of trouble. A protracted recession or a new banking crisis in the eurozone would blow it badly off course, writes George Parker.
Would the chancellor then be forced into plan B: deferring deficit reduction and opening the taps on public spending? He insists the answer to a debt crisis is not more borrowing, but pressure from Labour would be intense.
With recovery deferred, the coalition, which hoped to fight the 2015 election with growth of 3 per cent, would go to the polls with the promise of more pain to come.
However eurozone leaders deal with a Greek exit, the repercussions could fundamentally change Britain’s relationship with the rest of Europe. If the eurozone’s answer is to accelerate a full fiscal and political union, Britain would be isolated from the main EU decisions. If the eurozone disintegrates amid political rancour, will it still be a club that Britons want to belong to?
Already, Labour and the Conservatives are hinting at a referendum, possibly to give a future government the mandate to renegotiate membership terms with Brussels. What if other EU members do not play ball? Then the British public might demand an “in/out” referendum. In those circumstances, all bets would be off.