The Treasury and Bank of England are making contingency plans for an "economic Armageddon" if the euro falls apart, business secretary Vince Cable said on Thursday as the European commission slashed its growth forecasts and predicted that the continent could be plunged back into recession next year.
With David Cameron warning that the moment of truth was approaching for the eurozone, ministers are resigned to a severe downgrade of UK growth and public finances when the Office for Budget Responsibility reports this month. Brussels officials said the outlook for the UK economy had deteriorated significantly throughout 2011 and its recovery was lagging rivals'.
The commission now expects the UK economy to expand just 0.7% this year, compared with a forecast of 1.7% in May. Growth for next year is forecast to be just 0.6%, a huge drop on the OBR spring forecast of 2.5 %. An increasingly impatient Cameron again urged the Germans to allow the European Central Bank (ECB) to "act now" and become lender of the last resort to save distressed euro-economies, seen by Britain as the only way to keep the euro from collapse and prevent a wider banking liquidity crisis.
His call came as fears rose that France could be next to be engulfed by the crisis. Brussels downgraded its forecasts for the eurozone's second biggest economy, prompting a sharp rise in benchmark bond yields in France to 3.48% – almost double what Germany pays to borrow money.
Pressure on Italy, where bond yields this week breached the 7% danger level, eased after it appeared that former EU commissioner Mario Monti would be installed as prime minister by the weekend, while in Greece his fellow technocrat Lucas Papademos emerged as the leader of the country's new coalition government after four days of talks.
However, British ministers reported that France was keeping pressure on the ECB day and night to override treaty regulations and take a more interventionist approach, creating a solution to the crisis before it spreads further. Nick Clegg has been pressing the Germans to expand the ECB's role for as long as three months.
Faced by the impasse, Cable admitted Britain was preparing for "all eventualities" in the eurozone, including the breakup of the single currency. "There's a lot of scenario planning in government, thinking about all possible outcomes, and the Treasury is doing that. It affects our trade and potentially, in this Armageddon narrative, it affects the banking system, but we're not there yet," he said.
The contingency planning covers the Financial Services Authority, the Bank of England and the Treasury. It is being led by Tom Scholar, the second Treasury permanent secretary, and is looking at emergency measures to keep the banking system going.
Cameron said on Thursday in a speech on UK growth said that the ECB should now act as the lender of last resort. "Italy is the third largest country in the eurozone," he said. "Its current state is a clear and present danger to the eurozone and the moment of truth is approaching. If the leaders of the eurozone want to save their currency then they, together with the institutions of the eurozone, must act now. The longer the delay, the greater the danger."
Britain is growing increasingly impatient with Berlin for blocking a French plan for the ECB to guarantee the eurozone bailout scheme, the European financial stability facility (EFSF). Separately, Germany shot down the idea discussed at the G20 meeting in Cannes that European countries could use their special drawing rights at the IMF to leverage the EFSF.
Berlin believes it would be wrong for the central bank to act as a lender of last resort because that would jeopardise its independence and fuel inflation.
The Guardian
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