Bill Jamieson: Loss of confidence in the euro is irreparable

IN GLOBAL markets and company boardrooms across the UK, confidence continues to evaporate. Many readers commented on the dark tone of my column here last week. I fear the mood has got darker still.

The blazing failure of Germany’s bond auction last week – it secured only ¤3.89 billion of bids for a ¤6 billion sale of new ten-year benchmark bonds – shocked markets world wide. “If Germany can only manage this sort of participation”, commented Mark Ostwald of Monument Securities, “what hope for the rest?” Despite protestations from Berlin not to read too much into this failure, it was seen as a growing avoidance of Eurozone assets across international markets – even German bonds hitherto regarded as rock solid. Bond yields in Spain, Italy and Portugal remain well into emergency levels.

Here in the UK, news of plant expansion by Toyota struggled to rise above a worsening hail of downbeat results and profit warnings from companies as varied as retail fashion group Arcadia and travel agent Thomas Cook.

In another appalling week for the stock market, shares fell again to complete a nine-day losing streak – the longest since January 2003.

Banks were again prominent casualties. Royal Bank of Scotland and Lloyds Banking Group were driven to 12 month lows. RBS below 18p – this against a “peak” earlier this year of 49.5p - tells you all you need to know about the collapse of the bank recovery story and the rock bottom level of confidence in the sector. Access to wholesale funding markets is drying up as banks rush for the euro exits.

Almost every business confidence survey now cites the unfolding Eurozone crisis as the main worry area, with the gathering flight of confidence from the UK’s single most important export market. In what is coming to look like a game of apocalyptic chicken, German Chancellor Angela Merkel is so far refusing to bow to pressure to climb down and support bail-out plans for debt stricken neighbouring economies. But why should she, given the electoral suicide note this would represent?

The failure of last Thursday’s meeting between Merkel, Nicolas Sarkozy and Mario Monti to reach any sign of agreement – yet another summit with yet another fruitless ending – added to the sense of events drifting relentlessly towards the rocks.

The view that Merkel is not for turning is a big shift in perception from that prevailing till now: that Germany would buckle under and that somehow the Eurozone would get back on to its normal “healthy” diet of confusion, muddle and fudge.

It might still do – only the damage to global confidence in the euro now looks irreparable. Financial institutions and governments are now starting to prepare contingency plans for what has been until now the unthinkable: the unravelling of the single currency. Indeed, it would be surprising if the Treasury and Germany’s own finance ministry has not already begun preparations for this most traumatic and perilous of outcomes.

This week’s front cover of The Economist could not have put it more starkly: it depicts a euro coin as a flaming comet plunging to earth under the heading “Is this really the end?” The most financially integrated region in the world, it says, “would be ripped apart by defaults, bank failures and the imposition of capital controls”. After speculating on a shattering into different pieces, “or a large block in the north and a fragmented south”, it warns that wild currency swings between those in the core and those in the periphery “would almost certainly bring the single market to a shuddering halt. The survival of the EU itself would be in doubt”.

Who in these conditions wants to hold euro denominated assets of any kind? And which businesses, dependent on imports from or exports to the Eurozone, can be other than deeply apprehensive as to the direction in which events are heading? Little wonder confidence is sinking like an ebb tide and share prices with it.

Last week Andrew Bailey, deputy head of the Prudential Business Unit at the Financial Services Authority, urged that British banks prepare for the worst-case of a disorderly break-up. While careful not to offer a view on whether this will happen, he added that this “must be within the realm of contingency planning”, and that failure to plan for the exit of a country from the euro would be “unsound risk management”. Bang goes what’s left of Project Merlin.

The extent of the hit to confidence here in the UK was revealed last week in the Bank of England’s Systemic Risk Survey of 68 heads of financial institutions – banks, building societies, hedge funds, asset managers and insurers. It found that more than half of respondents ranked the probability of a “high impact event” in the short term to be “high” or “very high”, with the probability of such an outcome over the medium term put at 60 per cent – the highest levels since the survey began in 2008.

The five items most cited were sovereign risk, the risk of an economic downturn, funding risk, risks around regulation and taxes and the risk of financial institution failure. As the survey was conducted more than a month ago (between 20 September and 21 October when markets were rallying on hopes of a euro settlement) the probability of a “high impact” event would score even higher on this Richter scale of risk.

This is the background against which Chancellor George Osborne will present his Autumn Statement next Tuesday. It could scarcely be worse, either on the perspective of the UK’s domestic economic prospects or on this wider view.

The Office for Budget Responsibility is almost certain to lower its growth forecasts for this year from 1.7 per cent to around one per cent, and for next, from 2.5 per cent also to one per cent. This is far short of the level needed to help the government meet its deficit reduction forecasts – so these, too, are set to take a hit. And remember – this is on the benign scenario that there is not a Eurozone default and that somehow the single currency crisis is patched up.

I do not set this out as a counsel of despair but as a plea for greater realism than is currently being shown over the risks we now face to our economy, our living standards and our social stability. In this context it is hard to say which is more malevolent – the 49 per cent average pay rises at the top of Britain’s companies, or the one-day strike for public sector pension benefits well above the average of those enjoyed by the private sector and which cannot be met other than by extra borrowing or cuts elsewhere. Both speak to an appallingly low level of understanding. Blindness, complacency or bloody-mindedness? I fear we are about to learn the hard way that with confidence falling at this rate, our national fortunes are never far behind.