The real UK plan B: protecting against euro chaos

By Hugo Dixon
December 2, 2011

By Hugo Dixon and George Hay
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Pundits say Britain needs a plan B to boost growth. What it really needs is a contingency scheme to handle a euro explosion. The central planks should be for the government to keep adequate fiscal firepower in reserve to handle a crisis and to shore up the country’s banks.

The two points are linked. If the government used all its fiscal headroom now in an attempt to prevent a double-dip recession, it might find it had no capacity to react if things go from bad to worse across the English Channel. Debt is already forecast to peak at 78 percent of GDP in 2014/2015, according to the Office for Budget Responsibility. But that assumes the euro zone finds a solution to its problems. If not, the UK will be dragged into a deep recession and its debt will balloon: the tax take would fall, social expenditure would rise and money would be pumped into the banks.

If the single currency breaks up, there will probably be banking panics across the euro zone. Britain’s lenders would also be vulnerable. That’s partly because they hold 15 billion pounds of the sovereign debt of Greece, Portugal, Italy, Spain and Ireland. But the main problem would be their 144 billion pound exposure to those countries’ private sectors. A euro collapse would turn many good loans bad. Royal Bank of Scotland, Barclays and Lloyds Banking Group would be the three banks most in the firing line.

Extra capital alone wouldn’t stop these banks running out of cash in the aftermath of a breakup. The government and Bank of England would also need to provide them with a liquidity backstop, as they did in 2008. As then, support could have two elements: the Treasury could guarantee new issues of wholesale bank debt; and the BoE could restart its Special Liquidity Scheme, which allowed lenders to swap illiquid assets for government bonds for a period of three years.

One option would be to wait until a breakup before doing any of this. But the UK might then find itself on the back foot, having to fight a full-blown panic. It would be better to get at least part of the contingency plan moving now.

Comments

What an exposure: 15 billion pounds…impressive! The authors finally marked it: this popular nonsense about contamination of sovereign debt. The authors had to include almost all countries in the world and still they only scraped 15 lousy billion pounds together. The authors disproved their own point by showing the facts. But thanks for the honesty.

As on the 144 billion pound to the private sector, please…one knows nothing about it, type of assets, hedge strategies, etc. Better worry about the leverage position of those banks. I can give the authors a couple of numbers on the UK economy that gives us Europeans the shivers. But you know what ? Lets swap the EU exposure to the UK for theirs to the EU. Then we know again who owns what. Just to be clear. See which economy will last a day.

The UK does very well thinking about the effect its self-inflicted hyperinflation of 5 % has on its credibility. Because with the UK central bank “stimulating packages” probably some investors are contemplating permanently higher long term lending rates. And the sorry thing of it is that the inflation hurts those few Brits that actually saved something. Not that there are many: average UKs household savings are infamously negative – just like in Greece.

Did I mention the 9 %, NINE PERCENT UK deficit gap yet – 230 billion pounds every year ?

Sorry. Get your priorities straight.

Posted by FBreughel1 | Report as abusive
 

hugo, really, this sounds like you are orchestrating the john bullish herd stampede for the exits, or is this a bit of tongue in cheek english eccentricity?

:rolling of eyes: just say, honestly in clarkson fashion, that you would like to leave the eu, except you can’t afford to … a bit like greek politicians – your’s shouldn’t have been let in either
and you support dave cameron’s idea that england’s interest always first and the eu is for cheap holidays in the sun

; ( the disappointment comes from reading your rather vapid, febrile response – wishing for better than 5 short stale paragraphs – breakingviews has good video interviews online, come on, sharpen the pen, no john bull

And remember your own marketing (small box on the right) – Reuters Breakingviews is the world’s leading source of agenda-setting financial insight.

financial insight!

…. Breakingviews has recently been acquired by Thomson Reuters – and the share price is down

Posted by scythe | Report as abusive
 

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