Europe News

UK Treasury Fears Effects of a Euro Break Up

By Chris Giles, Financial Times

Concern is growing in the Treasury over the “very, very great” risks to Britain if the euro breaks apart.

Steve Allen | Photodisc | Getty Images

George Osborne is expected to be optimistic about Britain’s economic potential in his speech to the Conservative party conference on Monday. But the chancellor will also be realistic about the threats that the country faces, which he sees coming mainly from the euro zone.

“From the modelling we have done, the uncertainty [about the single currency] is already affecting the recovery and the risks [of a break-up] would be very, very great,” a Treasury official told the Financial Times.

The public were urged last week to “celebrate those who fought to save sterling” in a pamphlet from Centre for Policy Studies think-tank by eurosceptic commentators Peter Oborne and Frances Weaver. However the chancellor is more worried about the dependence of Britain’s economy on the euro zone’s future, even though the UK stands outside the currency union.

“It is clear that a break-up of the euro is not in the interests of Britain,” Mr Osborne said last month.

Economists agreed. Staying out of the euro has afforded Britain little immunity from events across the Channel.

Jonathan Portes, director of the National Institute of Economic and Social Research, said in the event of a euro break-up Britain would suffer a direct impact through trade linkages, indirect effects via its financial ties to the euro zone and a broader hit to confidence. Together, these could be “pretty bad”, he said.

Stephen King, chief economist at HSBC, was more apocalyptic. “A euro break-up would be a disaster, threatening another Great Depression,” he said. Disentangling the millions of contracts and cross-border assets “would be a Herculean task that would surely threaten the fabric of the European financial system”.

Any recession in Europe would damage British exports, 40 percent of which go to euro zone countries. A failed euro would almost certainly fall in value, raising the relative price of sterling and worsening trading conditions for UK exporters.

But it is the financial linkages that are of greatest concern to economists, the Treasury and the Bank of England. British banks with assets across the euro zone would be hit hard by a break-up of the single currency and mass sovereign and country defaults. Even if money markets did not freeze again, as they did in 2008, banks would be forced to squeeze domestic credit even harder than now.

Jens Larsen, chief European economist at RBC Capital Markets, said: “I don’t think it is much of a guess to expect the resulting turmoil to wipe out what remains of the banking sector”.

Aside from its potential to trigger a domestic banking crisis – a possibility that is giving the financial policy committee of the Bank sleepless nights – a euro break-up would hit consumer confidence, encouraging households and companies to rein in their spending. A vicious spiral would develop between economic weakness and a fragile financial system.

Were this to happen, the government and the Bank would not be powerless to act. The Treasury could follow the 2009 route and use taxpayers’ money to recapitalise or nationalise banks, while the Bank could send the electronic money-printing presses into overdrive to ensure banks had sufficient liquidity.

In such circumstances, Michael Saunders of Citi said the task for the authorities would be “to try to make sure banks had oodles of capital and get as much stimulus as possible”.