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The Eurozone Crisis – Potential Impacts New Economy Briefing Alan Wilson [email protected] 24 October 2012 Outline Economic background Has the ECB done enough to stave off break-up? What might the consequences be? Synchronised global slowdown Manufacturing Purchasing Managers' Index Index 65 60 55 50 45 40 US Eurozone Japan UK 35 30 Values above 50 indicate expansion in activity; values below 50 indicate contraction 25 2005 2006 Source : PMI/Markit 3 2007 2008 2009 2010 2011 2012 Even the emergers have slowed… BRICs: Industrial output % year (3 month average) China 20 15 India 10 5 0 Brazil -5 -10 -15 Russia -20 2001 2003 Source: Haver Analytics 2005 2007 2009 2011 …though public finances allow for stimulus Budget deficits and government debt in 2011 Debt as a % of GDP 250 Japan 200 Greece 150 Singapore 100 Germany Korea 50 Turkey Thailand Brazil Taiwan China Russia Italy France US Hungary UK Malaysia India Poland Spain 0 0 2 Source : Oxford Economics 4 6 8 10 Deficit as a % of GDP Outlook for UK export markets has weakened… Changes to GDP forecasts (Jun12 - Oct12) Difference compared with June 2012 forecast (%pts) 0.5 0.0 -0.5 -1.0 -1.5 -2.0 Eurozone Other EU US -2.5 BRICs -3.0 Rest of the world -3.5 2010 2011 UK: Goods & services exports by destination (2011) 2012 2013 2014 2015 2016 2017 Rest of the world 30% Source : Oxford Economics BRICs 6% Eurozone 42% US 16% Source : ONS 'Pink Book' Other EU 6% Oxford global forecast (50% probability) Steps to ensure Eurozone survival are taken, although they are not enough to kick start significant growth Risk premia fall, and consumer and business confidence gradually recover Recovery limited by public and private deleveraging and weak job growth EMs robust as policy eases and growing middle class support consumer spending and trade Gradual UK recovery UK: GDP forecast % year 6 Forecast 4 2 0 -2 -4 -6 -8 2005 2007 2009 Source : Oxford Economics 2011 2013 2015 Eurozone crisis not the only risk What do you consider to be the biggest 'tail risk' Sep-12 Aug-12 US fiscal 'cliff' EU sovereign debt funding Other Chinese real estate market Commodity price / Iran-Israel risk 0 10 Source: Bank of America Merrill Lynch 20 30 40 50 % saying Impact of Scenarios on the UK economy Global scenarios UK GDP % difference from baseline at trough/peak 10.0 5.0 Upside US fiscal cliff Baseline 0.0 China hardlanding Grexit -5.0 Eurozone Multiple exits -10.0 -6.0 -4.0 -2.0 0.0 2.0 4.0 6.0 UK CPI % diff. from baseline at trough/peak Source : Oxford Economics Breakup looked imminent… Fear of a breakup ■ Potentially toxic as it paralyses financial and physical investment ■ ECB action targeted to address this risk. ■ Imminent breakup now seen less likely Too tight fiscal policy ■ Austerity has become part of the problem instead of the solution ■ Where has the Growth Pact gone? Social cost of reforms ■ Correcting competitiveness and current account imbalances comes at a cost of (very) high unemployment for a (very) long time Slow pace of politics …and had already started in banking Typical interest rates on loans to businesses % 8.0 7.0 Spain 6.0 5.0 4.0 Germany 3.0 2.0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source : ECB 12 … which prompted very strong ECB pledge to intervene Sovereign bond spreads % spread over German bunds 6.5 Spain 6.0 5.5 5.0 Italy 4.5 4.0 3.5 3.0 2.5 2.0 01-Sep-11 24-Nov-11 16-Feb-12 10-May-12 Source: Oxford Economics\Haver Analytics 13 02-Aug-12 … but headwinds abound Fear of a breakup ■ Potentially toxic as it paralyses financial and physical investment ■ ECB action targeted to address this risk. ■ Imminent breakup now seen less likely Too tight fiscal policy ■ Austerity has become part of the problem instead of the solution ■ Where has the Growth Pact gone? Social cost of reforms ■ Correcting competitiveness and current account imbalances comes at a cost of (very) high unemployment for a (very) long time Slow pace of politics Public sector deleveraging to take years… Discretionary fiscal tightening, 2011-13 % of GDP, total 2011-13 Germany France UK Eurozone Italy Greece Ireland Portugal Spain 0 2 4 Source : Oxford Economics/ Haver Analytics 15 6 8 10 … and debt not back to pre-crisis by end of decade Eurozone: government debt % of GDP 100 90 80 70 60 50 40 2000 2003 2006 2009 2012 2015 Source : Oxford Economics/Haver Analytics 16 2018 2021 Fiscal multipliers reinforce the problem Fiscal tightening vs growth Annual average GDP growth, 2010-12 4.0 Germany 3.0 US 2.0 UK Spain 1.0 0.0 Italy -1.0 -2.0 Portugal -3.0 -4.0 y = -1.65x + 2.40 R 2 = 0.93 -5.0 Greece -6.0 0 1 Source : Oxford Economics 2 3 4 5 Average fiscal tightening 2010-12, % of GDP Reforms slowed by associated social costs Fear of a breakup ■ Potentially toxic as it paralyses financial and physical investment ■ ECB action targeted to address this risk. ■ Imminent breakup now seen less likely Too tight fiscal policy ■ Austerity has become part of the problem instead of the solution ■ Where has the Growth Pact gone? Social cost of reforms ■ Correcting competitiveness and current account imbalances comes at a cost of (very) high unemployment for a (very) long time Slow pace of politics Competitiveness disparities still to be addressed… Unit labour costs 2000=100 160 Greece 150 140 Italy 130 120 France 110 100 Germany 90 Spain 80 2000 2002 Source: Oxford Economics 19 2004 2006 2008 2010 2012 …but medicine is socially painful Eurozone: Unemployment rate % 30 Greece 26 22 Spain 18 Portugal 14 10 Eurozone 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 20 16 6 Source: Oxford Economics What is needed to hold Eurozone together? ECB even more interventionist ■ unlimited bond purchases / possibly more Long Term Refinancing Operations (LTRO). More bailouts ■ Greece allowed to not pay interest on debt to IMF, ECB etc and debt restructured ■ Full bailout for Spain ■ Further bailout for Portugal Move towards fiscal & banking union ■ ECB to supervise all banks and set common rules ■ Eurozone-wide deposit guarantee scheme ■ Formalisation of transfers in fiscal union – including Eurozone bonds Change in macro policy ■ Looser fiscal policy where there is room Will it happen? Economic cost of collapse would be enormous ■ Future direction of European Union would also be challenged ■ Do not underestimate political investment in Eurozone So, our baseline forecast is that policy-makers will ultimately do whatever is needed to hold Eurozone together ■ But the reform process will be erratic and slow ■ Some kind of ‘lost decade’ now seems most likely scenario Breakup risk remains high in medium term Piecemeal policy action leading to Eurozone’s lost decade? Eurozone GDP growth % point difference from historical average (2.3% pa) 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 2010 2012 Source : Oxford Economics 23 2014 2016 2018 2020 2022 Eurozone exits (Probability 25%) Scenario of multiple exits in 2014Q1 Fiscal austerity in Greece becomes unbearable; government falls Similar developments in other peripheral countries as growth and jobs fail to return Run on banks, massive shock to confidence, debt default This has very significant ramifications for the UK Eurozone GDP growth drops to -6% Eurozone*: GDP % year Forecast 6 4 Baseline 2 0 -2 -4 Multiple exits -6 -8 * Remaining countries -10 2005 2007 2009 2011 Source : Oxford Economics/Haver Analytics 2013 2015 2017 UK hit almost as hard as in the financial crisis… UK: GDP % year 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 2005 Forecast Baseline Multiple exits 2007 2009 2011 Source : Oxford Economics/Haver Analytics 2013 2015 2017 …as exports fall… UK: Exports % year 30 Forecast 25 20 Baseline 15 10 5 0 -5 Multiple exits -10 -15 2005 2007 2009 2011 Source : Oxford Economics/Haver Analytics 2013 2015 2017 …recovery in consumer spending is killed off… UK: Consumer Expenditure % year Forecast 6 4 Baseline 2 0 -2 -4 -6 2005 Multiple exits 2007 2009 2011 Source : Oxford Economics/Haver Analytics 2013 2015 2017 …and companies reduce investment UK: Fixed Investment % year Forecast 15 10 Baseline 5 0 -5 Multiple exits -10 -15 -20 2005 2007 2009 2011 Source : Oxford Economics/Haver Analytics 2013 2015 2017 Rates would cut rates to zero and more QE… US: RSH % 7 Baseline Forecast 6 5 4 3 2 Multiple exits 1 0 2005 2007 2009 2011 Source : Oxford Economics/Haver Analytics 2013 2015 2017 …but house prices would still fall UK: House prices Level Forecast 200 Baseline 190 180 170 160 150 140 130 120 Multiple exits 110 100 2005 2007 2009 2011 Source : Oxford Economics/Haver Analytics 2013 2015 2017 Summary International backdrop has deteriorated, particularly in the Eurozone but also in emergers Major central banks have taken out extra insurance in response and emergers have scope to use monetary and fiscal policy to soft land We expect the UK to return to growth in 2013 with growth of 1.2% followed by growth of 2.3% in 2014, driven by domestic demand US fiscal cliff would delay UK recovery by yet another year Multiple Eurozone exits would have a much more serious impact – deep recession and deflation North West already hit hard by recession, and Greater Manchester unlikely to see growth before around 2017 if this happens.