They want to renegotiate the current EU treaty to allow a bit more fiscal freedom and slower debt repayments. And now, for the first time, there is serious talk among central bankers that Greece might leave the euro. Meanwhile, the rescue of one of Spain’s biggest banks caused yet more turbulence and led to worries that Spain may soon be the fourth Eurozone country to ask for a bailout. It’s not pretty, but there is some hope. The weaker euro exchange rate will boost competitiveness. This should help, especially now that US consumers are spending more on imports and the summer holiday season is approaching. But don’t mention holidays to the Portuguese. Their government has cancelled more than a quarter of their public holidays in an effort to boost growth.
Greek political stalemate threatens its Euro membership
The breakdown of talks to secure a coalition government in Greece has raised worries that it won’t meet its bailout conditions. The longer the politics take, the worse the markets’ reaction is, which creates more instability. The current situation has led to serious talks about Greece’s future membership of the club. While exit might seem a simple solution when said quickly, the reality is far more complex. Unwinding the Greek economy not only has domestic implications, but it points the spotlight on the other struggling countries. While the political will is still to keep the Eurozone together, with events moving so fast, it would be short-sighted of policymakers not to consider options for an orderly exit for Greece.
The ongoing crisis hits the Eurozone exchange rate
Turbulence in the Eurozone has unsettled the currency markets too. The Euro/Sterling exchange rate dropped to its lowest since November 2008, making £1 now worth €1.24 (or €1= 80p). Sterling has been boosted by a cautious monetary policy and a bit of safe haven status as nervous investors looked for non-euro homes for their cash. And it looks like the euro may fall further. The European Commission’s spring forecasts predict output in the euro area will shrink by 0.3% in 2012 before returning to growth of 1%, in 2013. But even this is across the whole region. Greece, Portugal and Spain are expected to contract in 2012 and Spain is forecast to remain in recession in 2013. The only good news is that the weaker currency will help Eurozone exports and provide some boost to growth.
UK industrial production continues to decline
Overall industrial production continued to sag in March. A 2.6%y/y decline in the month marks the 13th consecutive fall. Energy and mining and quarrying were the culprits, but manufacturing declined 0.9%y/y despite a broadly based 0.9%m/m growth in March. This won’t be helped by a stronger pound. Sterling has appreciated by 12% against a basket of trade weighted currencies since its trough in 2009. UK holidaymakers making their way to the continent will be happy, but exporters won’t be. It will fuel the critics who say that the UK’s problem is that it no longer produces anything. But this argument has flaws.
UK policy rates are stuck fast
The Monetary Policy Committee (MPC) left rates unchanged again in May. And they are likely to stay there until well into 2015. The Committee has to take into account the risk that weak Q1 GDP numbers and turbulence in the Eurozone will be catalysts for below target inflation in future. With so much changing the MPC is waiting to see how things settle. The balance may swing back towards looser policy, but we'll have to wait for the whole story in this week's Inflation Report.
Low UK policy rates help UK arrears and possessions improve
The Council of Mortgage Lenders reported that UK possessions are still low given economic conditions. Low interest rates have helped, but nothing is without risk. While the total number of arrears cases fell in Q1, there was an increase in the number of serious cases. Deterioration in the labour market could easily push these into possession.
Chinese authorities move to support its economy after a wave of disappointing data
The most recent batch of Chinese economic data suggests sluggish growth by Chinese standards. Industrial production grew by 'only' 9.3% y/y in April, the slowest pace since the depths of the financial crisis in early 2009. Retail sales were also disappointing and inflation fell from 3.6% in March to 3.4% in April. The Chinese authorities responded by loosening monetary policy by cutting the reserve requirement ratio at the weekend. But it’s unlikely to be the end of measures to stimulate the economy.