Bill Jamieson: Chancellor readies his ‘Plan A Plus’

Barely had the massive crowds dispersed from Buckingham Palace than “More bad news on the euro” was climbing back to the top of the news agenda. It is now hard to tell which is worse: a sustained programme of root canal treatment at the dentist’s or keeping up with the euro crisis. Both have a driller-killer quality to them.

Every downward twist sends the eurozone economies further into recession, dampening export prospects here while adding further to our own problems of unable-to-lend banks. Whether some IMF/EU-wide bank rescue plan is launched or the euro-muddle continues with its dizzying round of crisis summits and ad hoc pronouncements, the UK will be on the hook.

But it is not just the eurozone that is giving the Treasury sleepless nights. From America last week came poor employment numbers, casting doubt on the strength and sustainability of the US recovery. Little wonder there is growing panic in the Obama camp about getting the eurozone to agree a “road map” to resolve the crisis before November. And recent data from China pointed to a marked slowdown in growth. So, as if the domestic evidence was not enough to set alarm bells ringing, there is now ample evidence that the government cannot keep asking us to believe in a recovery that isn’t even in sight.

The options for Chancellor George Osborne now look stark. Stick with Plan A? Switch to Plan B? Or muddle through the summer until Plan Panic sets in? “Autumn budget crisis” is a familiar toe-tapping number, as cheesy as any from Cliff Richard or Shirley Bassey. But this one is so evident on the horizon that markets have no reason to wait until September to force the pace. If the Chancellor wants to avoid being the victim of events by introducing pre-emptive measures, then some evidence of them need to be in place very soon.

Unfortunately, he finds himself well and truly boxed in. He has bet the coalition on a five-year budget deficit reduction and growth recovery plan – and is dependent on that growth to deliver that deficit reduction. Dream on. Official data shows the economy to have relapsed into two successive quarters of contraction, and the more recent pointers suggest matters may be getting worse. The construction purchasing managers’ survey for May, out earlier this week, shows a loss of momentum, not only in business activity but also in new business growth. Confidence in the sector has also fallen to a seven-month low.

Nor do the woes stop here. The retail sector, where cold and wet weather in April and May kept customers away from the shops, is on its knees. The banking system is still severely impaired, with no early prospect of repair. And while this remains the case it is wrong to keep exhorting small and medium-sized companies to expand and take on staff where there is neither the finance to make that possible or the demand to justify the investment.

Osborne has already shifted the deficit reduction goalposts once. He cannot do this a second time without a loss of credibility. And he cannot plunge into an early announcement of a resort to Plan B without conceding a huge political victory to shadow chancellor Ed Balls. Public confidence in the coalition’s handling of the economy is now on the slide.

In any serious assessment of what to do, the government has to weigh the consequences of taking emergency action against carrying on with unchanged policy. There is a growing view across business that the risks attached to doing nothing are now rising sharply. In the words of Michael Saunders, chief UK economist at Citigroup: “The UK’s economic position and prospects are sufficiently gloomy that action is more likely and less risky than inaction.”

So stand by, not for Plan B but for “new improved Plan A Plus”. Its first feature would be a further bout of Quantitative Easing by the Bank of England, probably extending to an additional £50 billion. This may take a more targeted form, with the Bank buying corporate bonds or packages of loans to SMEs. Bank action has hitherto been called “monetary policy”. In fact, the more it has been drawn into emergency measures, as now, the more it has become a de facto agent of fiscal policy, given carte blanche to pursue economic stimulus by the back door. Some of the new QE money could end up helping to finance government guarantees and financial assistance on infrastructure projects currently stuck in the planning and protocol pipeline.

Direct fiscal stimulus – as in resorting to traditional deficit spending and borrowing – is unlikely immediately, though there could be temporary and targeted tax cuts to boost spending and to help business. Cutting the VAT rate on home renovations, for example, could boost consumer spending and help the beleaguered building industry. Schemes to encourage pension fund investment in infrastructure projects are also likely to emerge.

“Plan A Plus” may not be complete until the Autumn Statement. If the euro crisis escalates, as seems likely, with all the consequent adverse effects on the UK, Osborne may be compelled to break his own deficit reduction targets to prevent serious economic dislocation. As most other countries will be doing the same, the Chancellor could retreat in the international scramble to emergency stations. Nevertheless, it exposes the coalition government to its greatest risk so far, and its survival should not be taken for granted.

Will it really come to this? The problem in the eurozone is that almost all options, barring direct imposition of central economic control, have been played out in a deadly game of chicken. Talk of a plan to recapitalise Europe’s banks quickly subsided yesterday on the realisation that the sums involved would exceed the resources of smaller eurozone states and involve Germany carrying the lion’s share.

Angela Merkel may urge the harmonisation of deposit insurance rules, but has given no indication that she is ready to go along with an arrangement whereby Germany would assume a disproportionate share of the costs of recapitalising stricken banks in other eurozone states. Proposals for fiscal union founder on the rock of voter antipathy.

Thus we are back to ad hoc proposals, more crisis summits and euro muddle as Europe’s economies tank. And in that outcome, don’t be surprised if the markets reach out and press P for Panic.