The stunning move by six central banks to announce emergency measures to push more dollars into the financial system shows just how desperate the authorities are to “ease strains in financial markets” that are making it difficult for some banks to operate as easily as normal.
Jon Peace, head of European bank research at Nomura, said: “It is an evolution of the crisis from three years ago, when countries took on the risks of the banks. Back in 2008, there was a lender of last resort – countries bailed out banks. This time it is governments that need a lender of last resort – but there is no obvious lender of last resort.”
While the massive bank bailouts of October 2008 – in the month after Lehman collapsed – worked for a while in shoring up banks, confidence is again ebbing , even though the banks are much stronger then they were three years ago. This time the problems for banks is not the holes ripped through their books by exposure to US sub-prime loans, but their exposure to the governments of the eurozone – which are in turn searching for their own bailouts.
John Higgins of Capital Economics said: “We are in the latest leg of a crisis that began several years ago, but this time the source of the banks’ concerns is not their exposure to asset-backed securities and more about exposure to sovereign debt. And there is the concern about the ramifications of the break up of monetary union.”
The risk of the eurozone imploding is being taken seriously by regulators. The Financial Services Authority, while not predicting a eurozone collapse, has told UK banks to draw up contingency plans for such an outcome, while Bank of England governor Sir Mervyn King is expected to reiterate on Thursday the extent of the potential problem when he publishes his risk list for the financial system.
Ratings agency Standard Poor’s added to the collection of banks’ problems yesterday by reducing the ratings of a raft of banks – including that of Dutch bank Rabobank, which had been the last bank in the world to have a triple-A rating. The share prices of Britain’s banks also tell a story of a lack of appetite among investors to own bank shares – which some analysts argue is because of concern about the regulatory environment for banks.
Shares in the bailed-out Lloyds Banking Group (24p) and Royal Bank of Scotland (20p) have flirted with levels last visited more than 18 months ago.
But eurozone banks may be more on the policymakers’ minds. The funding announced by central banks on Wednesday was first introduced in the dramatic days after Lehman Brothers collapsed, but the latest announcement makes it even cheaper for banks to get access to dollars.
Crucially, though, no UK-based bank has asked the Bank of England for funding this way since November 2009.
Explaining why getting access to dollars funding is important, Peace said: “The French banks do a lot of dollar-based lending, but there’s not a natural source of deposits so they do it by wholesale funding [borrowing huge sums on the international money markets]. But US money market funds have withdrawn their exposure to European banks because they are worried about the sovereign risk.” One industry source added: “It’s not fatal, but it’s painful.”
Again it comes back to the eurozone.
Robert Talbut, chief investment officer at Royal London Asset Management, said: “There is a belief that fiscal consolidation on its own, if replicated by a large number of countries, is ultimately unsustainable. If everybody is cutting, then growth is damaged for everyone, with the real danger that company and consumer confidence spirals downward leading to further falls in growth and a collapse in confidence in the whole financial and business system,” he said.
“Once you start to undermine confidence in the sovereign debt markets, and therefore banks, you cause huge problems for banks as they attempt to fund both themselves and their customers.”
Talbut is not alone in believing that what is needed is a dramatic change in the role of the European Central Bank. Others argue that banks, already holding more capital that can absorb losses than they did when Lehman collapsed, need even further change.
Lord Oakeshott, the Liberal Democrat peer who resigned over the lax treatment of banks by the coalition, argues that now more than ever the proposals by the Independent Commission on Banking, chaired by Sir John Vickers, should be implemented.
“Until we force through the Vickers reforms and make our bloated banking sector safe, the British economy will keep hovering on the edge of an abyss. We are still desperately vulnerable to financial shocks from the rest of Europe or even the US,” Oakeshott said.
Europe’s leaders are faced with a stark deadline of 10 days to save the euro or face the disintegration of the European Union itself.
The warning from Olli Rehn, EU economic and monetary affairs commissioner, came after central banks intervened to prevent a complete freezing-over of the west’s financial sector because of the politicians’ continued failure to resolve the sovereign debt crisis.
EU finance ministers were told bluntly that, with eurozone unemployment at 16.3m or 10.3% – the highest level since the single currency was introduced – an unchecked debt and banking crisis would push Europe into a deep slump and drag the rest of the world with it.
Herman Van Rompuy, the European Council president, charged with preparing yet another make-or-break EU summit next week, said: “The trouble has become systemic. We are witnessing a fully blown confidence crisis.”
The eurozone’s three most prominent leaders – Nicolas Sarkozy, Angela Merkel and Mario Monti – are due to set out over the next five days how they envisage Europe’s political class regaining supremacy over volatile but dominant financial markets – and restoring confidence among panicky investors.
On Thursday night the French president will set out his case for a tight fiscal union in a speech in Toulon and the German chancellor will follow suit a day later with her basic plans for a “stability union”.
On Monday Monti, Italy’s new technocrat premier, will spell out €25bn of budget savings, including a freeze on index-linked rises in pensions and cuts in deputies’ allowances, next year.
After day-long talks among the EU’s 27 finance ministers, Jacek Rostowski, Polish finance minister and current chairman of Ecofin, the economic and finance ministers’ group, said the 8-9 December summit would have to be rapidly followed by “extremely forceful” action to stabilise markets.
Anders Borg, the Swedish finance minister, said much depended on Rome. “I think the market will not provide for honeymoons. They need to bring out all the skeletons so we can see a step forward when it comes to credibility in their debt market.”
Before the summit the European Central Bank (ECB) is widely expected to deliver a further cut in interest rates to 1% and/or more “non-standard” measures to extend loans to banks to last up to three years. “The rise in unemployment confirms that the financial crisis is reaching the real economy,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland.
The Organisation for Economic Co-operation and Development on Monday slashed its eurozone growth forecast from 2% to 0.2% next year; other analysts say the area is already in recession.
The ECB – and the International Monetary Fund (IMF) – are central to the deliberations of EU leaders, including finance ministers. The aim is to reach a consensus by next week that the lending resources of the IMF will be extended so it can help boost the financial firewall against contagion to Italy and Spain of the main bailout fund, the EFSF.
It is by no means clear how this will be done and, critically, what role the ECB should play in this process – but yesterday Wolfgang Schäuble, the German finance minister, lifted a Berlin veto on an extended IMF role – provided the Bundesbank agrees. He said: “We are prepared to increase the resources of the IMF through bilateral loans. If the IMF wants to widen its freedom to take action by increasing the special drawing rights [SDRs] then we are prepared to talk about that.”
That would avoid direct ECB intervention but other finance ministers such as Belgium’s Didier Reynders are openly talking about a strong link between IMF and ECB action to tackle the crisis.
Elena Salgado, the outgoing Spanish economy minister, said: “Given the IMF’s role to date in Europe, it wouldn’t be unreasonable to involve it more.”
Sarkozy and Merkel are both expected to insist that this can only happen with strict agreement to enforce budgetary discipline – enshrined in national constitutions – and impose sanctions on recalcitrant sinners. Merkel wants six months at most in which to agree limited treaty changes.
Rehn took time out from the talks to tell MEPs: “The EMU [economic and monetary union] will either have to be completed through much deeper integration or we will have to accept a gradual disintegration of over half a century of European integration.”
Growing alarm that the European debt crisis is dragging down prospects for the world economy was underlined as the Chinese Central Bank eased lending requirements, in the clearest signal that policy makers have switched course from curbing inflation to shoring up growth.
The surprise announcement of a cut in the reserve ratio requirement – the amount that banks must hold relative to the amount they lend – came shortly before other central banks around the world took co-ordinated global action to avert a fresh credit crunch.
In China businesses are already complaining they have been squeezed by declining exports and a shortage of credit. The economy is now growing at its weakest rate since 2009. Analysts had anticipated the decision, but did not expect it to come so soon. The 50-basis-point cut, from a record high of 21.5% to 21%, is the first after almost three years of increases, although China used other measures to stimulate credit when the global economic crisis hit in 2008. It will come into force on 5 December.
“The public nature of this move … is a clear signal that Beijing has decided that the balance of risks now lies with growth, rather than inflation,” wrote Stephen Green, Standard Chartered’s China macroeconomist, in a note. “This is a big move.”
He added that the decision probably signalled that figures to be released on Thursday would show manufacturing was contracting. The purchasers’ managing index (PMI) fell unexpectedly last month from 51.2 to 50.4, 50 being the threshold that indicates whether the sector is likely to be growing or shrinking compared with the previous month.
Growth slowed to 9.1% in the third quarter, from 9.7% in the first quarter; the lowest rate since the second quarter of 2009. Inflation, previously the core concern for Beijing, has fallen back from a three-year high of 6.5% in July to 5.5% last month. Analysts suggested that Europe’s woes had accelerated the cut. “Beijing has been more than a little surprised by the speed with which things in Europe have been deteriorating,” said Michael Pettis, a professor at Peking University’s Guanghua school of management.
The growth rate in India has also slowed sharply, according to new data released yesterday. The rate of expansion dipped below 7% in the past three months – a level last seen in 2009 when India felt the impact of the global financial crisis. Asia’s third-largest economy had been targeting a growth rate of more than 10%.
High inflation, cuts and the longest period of wage stagnation on record will see the spending power of the average British family plummet over the next five years, a leading thinktank warned on Wednesday.
An Institute for Fiscal Studies analysis predicted that average incomes, adjusted for inflation, will fall by 3% this year and further in 2012. IFS director, Paul Johnson, said: “In the period 2009-10 to 2012-13m, real median household incomes will drop by a whopping 7.4% – a record matched only by the falls seen between 1974 and 1977.”
As up to two million public sector workers walked out in protest against changes to their pensions, and signs emerged of a potentially damaging rift within the Liberal Democrats in the wake of George Osborne‘s autumn statement, the thinktank warned that families with children will be worse off in 2016 than they were 14 years earlier as they cope with more than a decade of austerity.
Not since the Callaghan government of the mid-70s have families come near to suffering a similar loss of income as the one now predicted to hit Britain over the next five years, the IFS said.
Lower income groups, it confirmed, will bear the brunt of the government’s latest cuts, outlined by George Osborne on Tuesday. The chancellor’s autumn statement signalled that the deteriorating economic outlook meant that there would be two more years of austerity than originally planned in his March budget.
Anti-poverty campaigners said the IFS figures showed that the coalition had shifted the burden of paying for the deficit on to the most vulnerable.
Alison Garnham, chief executive of the charity Child Poverty Action Group, said: “The IFS analysis confirms that the chancellor’s new tax and benefit measures are a takeaway from low income families with children to those at the middle and top. It is particularly perverse to reduce incomes of the lowest paid working families by reducing tax credits when this is the group the government claims it wants to help through improved work incentives.”
The oil price shocks of the 1970s forced the then Labour government to survive on IMF handouts and push through steep spending cuts and public-sector wage freezes. But wages recovered their previous spending power within four years.
The IFS analysis of the UK’s current economic woes, and the coalition’s reaction to them, both suggest that real median household incomes – where higher wages and salaries are adjusted to account for higher prices – will be no higher in 2015 than they were in 2002. A couple with no children typically enjoyed a weekly income of £437 in 2002 but by 2015 that will have dropped in real terms to £433. For a couple with two children the weekly income falls from £612 in 2002 to £606 in 2015. In the nine years since 2002 the cost of living has increased 30%. The IFS analysis showed the unemployed and pensioners living on state benefits would do better than working families after benefits were linked to the 5.2% rise in inflation. Johnson said: “Failure to index some elements of tax credits, and the reversal of decisions to increase child tax credits in real terms, will leave some poorer families worse off and will lead to an increase in measured child poverty.”
The IFS based its estimates for the squeeze on incomes on forecasts from the Office for Budget Responsibility, the independent watchdog that oversees Treasury spending plans and which published its own outlook for the economy alongside Osborne’s statement. It blamed a repeat oil price shock for most of the cuts in real incomes suffered by UK households. High energy prices were the largest single element fuelling an inflationary spiral that left many families worse off.
TUC General Secretary Brendan Barber said there was an “unprecedented crisis” in living standards. “You can’t build a sustainable economic recovery on the back of people getting poorer,” he said.
“Rather than further hammering consumer confidence with public sector pay caps and cuts in working tax credits, the government needs to put greater emphasis on wage-led growth, starting with a fairer tax system where everyone – including the super-rich – pays their share.”
Shadow home secretary Yvette Cooper, said the IFS report revealed the poorest 30% of households would lose more than three times as much as the richest 30%.
Official data this week showed UK families’ weekly spending fell last year to the lowest in real terms for at least seven years. They cut back on spending on leisure to try to pay for housing, energy and transport costs. One of the big pressures facing households is high inflation, which has left most people worse off in real terms.
Pay growth for workers in Britain hit a record low between 2010 and 2011, according to official data last week. Pay was up just 0.4% on a year ago in terms of gross weekly earnings, meaning that incomes are tumbling in real terms, given that inflation stands at 5%. The Office for National Statistics also said the gap between Britain’s highest and lowest paid workers had widened dramatically over the past year.
The IFS said one group whose incomes “are certainly being squeezed” is public sector workers. Its analysis suggests that the two years of on average 1%-a-year pay rises in the public sector to follow the current two-year pay freeze would be enough to wipe out the estimated pay gap between men in the public sector and private sector.
The thinktank puts the gap between public and private earners at 4.3% for men, taking into account education, age and qualification levels. For women the public sector premium is 10.5% and for both men and women it stands at 7.5%.
The IFS also looked into differences in public sector benefits across the UK. “Looking at pay alone, public sector workers appear, on average, to do relatively badly in London and the south-east and really rather well in some other areas including Wales and the north of England,” Johnson said. The findings echo Osborne’s move on Tuesday to ask public sector pay review bodies to look into how pay can be made more responsive to local labour markets.
Following forecasts for contraction at the end of this year and barely any growth next year, Osborne was forced to concede on Tuesday that the UK risked falling into recession. The resulting strain on the public finances led the chancellor to pencil in two more years of substantial cuts.
“That will extend to six years the period for which total spending will have been cut year-on-year,” said Johnson. “One begins to run out of superlatives for describing quite how unprecedented that is.
“Certainly there has been no period like it in the UK in the last 60 years.”
The Liberal Democrats moved last night to defuse a potentially damaging internal row after Danny Alexander said the party would fight the next general election committed to £15bn in spending cuts for 2016 and 2017 that had been agreed with the Tories.
In remarks that caused concern to senior Lib Dem colleagues, the chief secretary to the Treasury said the parties would set out “well before the next general election” how they would deliver the extra savings in the next parliament.
Pressure to set out post-election spending plans has been forced on the parties by the deteriorating fiscal position set out by George Osborne in his autumn statement. The chancellor said lower growth meant a further £15bn of cuts would be needed in 2016 and 2017 to eliminate the structural deficit within five years.
“As a government we originally set out plans that would meet our targets a year early in 2014/15,” Alexander said on BBC 2′s Newsnight. “But because of the way that economic circumstances have deteriorated we need to make this commitment for future years, so yes Liberal Democrats and Conservatives will work together in government to set out plans for those following two years and, of course, we will both be committed to delivering them.
“We have just decided what the path of spending is in the following two years [after the election] and in due course will set out what that means in detail.”
Simon Hughes, the Lib Dem deputy leader, questioned the idea that the party could be committed to specific spending cuts after 2015. “All governments need to make spending plans for the longer term, but any spending plans from the government after 2015 can only be provisional and subject to the result of the general election,” he said.
“The Liberal Democrats will fight the next election on an independent manifesto which will be developed through our internal democratic structures, and without any collaboration or agreement with other political parties.”
It is understood that Alexander’s remarks also caused concern among Lib Dem cabinet members.
Alexander insisted the two parties would have separate election manifestos but his remarks imply they will not simply have the same fiscal objectives, but an agreed programme to meet those objectives.
The party said: “At the 2015 election the Liberal Democrats will fight as an independent party that delivers economic credibility and greater fairness.
“The coalition government’s autumn statement confirmed the spending totals for the first two years of the next parliament. We have not as a coalition government taken the decisions on the detailed breakdown of spending in these years, or even when those decisions will be taken.”
A spokesman suggested the two parties might settle a spending review before the election setting out how the cuts would be made, but neither party would be committed to these spending plans in the election.
The episode shows how the delay in eradicating the deficit makes it more difficult for the two parties to disengage before the election.
Asked what was the point of voters backing the Lib Dems, Alexander said: “There are a lot of points to vote Liberal Democrat rather than Conservative or Labour, but those are things that we will set out at the general election in our respective manifestos.”
Lord Oakeshott, a Lib Dem peer and ally of the business secretary, Vince Cable, questioned Alexander’s statement, saying: “The coalition agreement is for five years not seven. It is very dangerous for the Liberal Democrats to go into the next election tied like a tin can to the tails of the Tories, rather than as an independent party capable of forming an alliance with whoever we and the electorate choose. In the economic circumstances of the 20s and 30s, the Tories proved themselves to be past masters at swallowing up other parties. It would be very foolish if we were to make the same mistake again.”
Some Lib Dems argue that the two parties would lose credibility with the markets if details of spending cuts were withheld, adding that the party at the last election attacked Labour for failing to specify what would be cut. The current spending review ends months before the 2015 election.
Just in case the parallels between the eurozone debacle of 2011 and the banking meltdown of 2008 were not striking enough, Mervyn King and central banking chiefs from around the world decided to underline them on Wednesday – in red. What the Bank of England, together with the Federal Reserve in Washington and the central banks of the eurozone, Switzerland, Japan and Canada, did was jointly offer dollar loans at cut-price interest rates to cash-strapped banks. This was a dramatic move – and one that central banks have tried before, notably in the credit crunch of 2008. Just like then, it may soothe financiers’ jangled nerves and keep some banks in business, but it neither resolves the wider crisis, nor takes the pressure off European politicians to act.
Just as in earlier credit crunches, over the past few months banks in France, Italy and other parts of euroland have found it increasingly difficult to borrow the cash they need to go about their daily business. By agreeing to lend more money into the market, and to do so cheaply, central bankers are doing two things: first, propping up banks that might otherwise collapse; second, signalling that they are willing to step in as necessary. No wonder then, that markets around the world welcomed the move. But the reaction was driven more by sentiment than by intellect. For one, the European Central Bank has been lending hundreds of billions of euros to banks for weeks now – and it has not eased distress in the markets. And that’s because loans, even dauntingly large loans to tide banks over, do not sort out the root troubles in the eurozone.
Those problems are multiplying more productively than a warren full of rabbits. Let us start with the banks. Ask someone working in financial markets to name a European bank in serious trouble and they will suggest at least two names. Ask someone else and you will get a couple more. What the banking industry in Europe now faces is a rerun of the credit crunch of 2007-08, when banks wouldn’t lend to each other for fear that the other party was not solvent. The root cause this time is the loans that banks have already made to eurozone governments – and the fear that some countries will default on their debt. Greece has already done it, to the tune of asking banks to accept a 40% discount on its bonds; now the worry is that Italy or Spain will be next. This leads us to the problems around sovereign debt, and just what happens on that surely-not-too-distant day when another southern European government throws up its hands and admits that it cannot keep servicing its debts at interest rates of 7% and above. The official answer is that a bailout fund stands ready to help such distressed cases; the reality is that the pot is too small for a Spain, let alone an Italy. Just who stands behind the bailout fund, and on what terms, has been the running argument of the eurozone crisis for months. Germany won’t stump up enough. France says it can’t, for fear of jeopardising its credit rating – which has led to increasingly outlandish suggestions. The ECB will step in! The IMF will help! The Chinese will chip in! It would be farcical, were it not for the very real prospect that next year is now likely to bring another nation defaulting on its loans and perhaps a big country leaving the euro altogether. What would be the effects of that? The OECD thinktank described them this week as “massive wealth destruction, bankruptcies and a collapse in confidence … a deep depression in both the exiting and remaining euro area countries as well as in the world economy”.
Which includes Britain. The impact of the last great banking crisis on the UK has already been devastating. The Institute for Fiscal Studies yesterday forecast that the average household will have no more disposable income in 2016 than they had in 2002. That is shocking enough; it is also a sobering reminder of the risks to the UK if a euro meltdown is not averted.