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Eurozone crisis live: UK would suffer ‘deep recession’ if eurozone fragments

• IFS predicts two-year slump if eurozone breaks up
• 10% risk Italy, Spain, Portugal, Ireland+Greece quit euro
Eurozone manufacturing output drops in January
Greece mired in recession, but Germany’s doing OK.
• UK manufacturing returns to growth
• The agenda

2.45pm: Healthy rally on Wall Street this afternoon, with the Dow Jones industrial average up 101 points (or 0.8%). Risk is back, on both sides of the Atlantic.

2.16pm: Below the line, RobertSchuman asked for more details of the Institute for Fiscal Studies’ warning about the impact of the eurozone on the UK economy. So here goes:

Within its Green Budget, the IFS warns that its central forecast (that the UK grows by 0.3% in 2012), would be undermined in the event that the eurozone breaks up. It estimates that there is a 30% risk of a disorderly default in Greece, and a 10% risk of a ‘broad eurozone break-up’.

Under the latter scenario, Greece, Portugal, Ireland, Italy and Spain woould all leave the euro and establish new currencies. From the report:

Broad Eurozone break-up could result from the failure of the authorities to agree a credible and permanent solution to the crisis, leading financial and business confidence to collapse.

Italy and Spain would be unable to refinance debt maturing in early 2012, triggering a series of disorderly defaults. With the peripheral economies unwilling to accept even greater austerity measures, the Eurozone would then break apart.

As this graph shows, such a scenario would send world GDP growth spiralling down, and also prompt a new credit crunch [due to the write-downs and losses that a five-country default would provoke].

“Policy response in developing markets” is the only factor that would save the global economy from outright recession.

For the UK, as mentioned before, this worst-case scenario would push Britain into a second deep recession with GDP falling by 1.7% in 2012 and 0.9% in 2013. Unemployment would hit 10.7%.

Oxford Economics (who co-produced the report), based the assumptions on UK’s exposure to bank and private sector debt.

British banks are relatively well insulated from peripheral eurozone debt, but our modern inter-connected financial system means the UK banking sector would be hit hard.

Grimly, the IFS reckons this second (hypothetical) recession would be less deep than the 2008-2009 slump because there is simply less scope for businesses to cut back this time around.

You can see the full report here.

1.51pm: Intriguing developments in Ireland this afternoon — left-wing members of the Irish parliament are planning to petition the Republic’s President to use an article in Ireland’s constitution which they believe would force a new referendum on the latest European treaty.

Henry McDonald, our correspondent in Dublin, reports:

The so-called Technical Group in the Dail will call on President Michael D Higgins to use one of his few powers – a move that could trigger a constitutional crisis in the country.

Under Article 27 of the Constitution the President can refer a Bill to referendum provided at least one third of the Dail and the majority of the Irish Seanad support it.

The group consists of 16 left wing deputies, who have called on other members of both the Dail and the lower house Seanad to support them.

Currently, Ireland’s Attorney General Maire Whelan is examining the fiscal compact to determine whether the Government is legally bound to hold a referendum.

Enda Kenny would rather avoid a public vote. But opposition leaders in Fianna Fail and Sinn Fein have insisted the Irish public should have their say.

Back in June 2008, the Republic rejected the Lisbon Treaty at a public vote, only to approve it at a second referendum 16 months later.

Fianna Fail leader Micheal Martin, claims that pushing the treaty through without a referendum would damage the people’s confidence in any future European Union initiatives. Martin said:

For the sake of rushing through this treaty, we could damage the possibility of ever again winning support for an EU initiative….Given that this treaty commits us to a new major EU treaty in the next few years, this is an urgent concern.

Sinn Fein’s Padraig Mac Lochlainn said the treaty was “a suicide pact” and the public should be given a voice.

Under the deal agreed in Brussels, euro countries cannot receive support from the European Stability Fund unless they have approved the fiscal compact.

1.24pm: Louise Cooper of BGC Partners has put together a graph showing how the price of Portuguese bonds sold in Portugal, and those sold through the London bond market, have diverged in the past few weeks.

The key difference between the two kinds of bond is that the London-issued debt includes tougher protective covenants for bond-holders. These covenants have taken on more significance since it became clear that Greece’s debt restructuring might not trigger credit default swaps (depending whether the deal is treated as a Credit Event).

Louise explains:

Financial Markets are telling us that Portugal is next, that it will need its own debt restructuring plan despite what its politicians and the ECB say.

As default threatens, market participants start to scrutinise the legal structures of the bonds that they own – we all become experts in things we never knew like Collective Action Clauses. Well just like Greece, Portugal issued debt primarily under its own laws, but there are some issuances under more creditor friendly English law.

12.51pm: Der Spiegel has rounded-up the German media’s reaction to Monday’s EU summit here. It’s interesting for a couple of reasons — German commentators are generally supportive of the (swiftly-dropped) idea of embedding a EU official in Athens within the Greek government, but concerned that Germany is scaring other European countries.

Die Welt argues that Greece’s best hope is to quit the eurozone: “They have to go their own way with the freedom afforded by exchange rate movements and with a strong stimulus of economic growth.” The pennydrachma may have dropped that tougher fiscal controls and more austerity alone won’t work.

Süddeutsche Zeitung harks back to the second World War, warning that Germany revived bad memories with its proposal for an austerty commissioner:

The idea to impose an austerity commissioner on Greece was insensitive, as was the demand made by FDP leader Philipp Rösler for ‘leadership and monitoring of Greece.’

The Germans led Greece before, and though the massacres of Distomo and Kefalonia have nothing to do with today’s euro crisis, such foolish tirades only fan the hysteria and the resistance.

If you watched Guido Westerwelle, Germany’s finance minister, visit London in December, you’ll remember how passionately he spoke about Germany’s responsibilities in Europe today [this video clip shows some of the press conference.] WW2 was also cited by many politicians in Germany and Austria last autumn during the debates on whether to expand the European bailout fund.

12.19pm: Looking back at the Institute for Fiscal Studies report this morning — the IFS is arguing that George Osborne should consider some form of fiscal stimulus in next month’s budget.

PA explains:

The IFS said there was a “strong case” for Mr Osborne to forego medium-term tax or spending giveaways in his March Budget – though it said there might be scope for tax cuts equivalent to 2p off the main rate of income tax in future years if the economy develops favourably.

But the thinktank said there was a stronger argument for a “timely, targeted and temporary” fiscal stimulus of £10-20 billion, funded by borrowing, in March to boost growth in the short term.

This could come as a temporary cut in VAT or employers’ National Insurance contributions or a hike in investment spending.

But the IFS said the case for a fiscal stimulus – of the kind demanded by shadow chancellor Ed Balls – was “not clear cut” because of the risk of driving up gilt yields and the uncertainties surrounding the future of the eurozone.

11.55pm: Credit crunch fears reared up this morning, after the European Central Bank warned that Europe’s financial institutions tightened credit standards in the fourth quarter.

The ECB’s quarterly Bank Lending Survey also found that banks expect to make it harder for businesses and individuals to obtain loans in the first three months of this year. There was also a drop in demand for mortgages and other home loans.

The Financial Times has a good take here, suggesting that

December’s unprecedented injection into the financial system by the ECB of €489bn in cheap three-year loans had failed to prevent a retrenchment by banks that could hamper the region’s economic recovery.

So Mario Draghi’s splurge of low-cost borrowing may have pushed bond yields down, but hasn’t done much for the wider economy….

11.25am: This morning’s debt auctions saw Portugal and Germany’s borrowing costs both drop.

There was relief for Portugal as a sale of €1.5bn of short-term bonds went without a hitch. The yields on three-month bonds fell to 4.06%, down from 4.34% in mid-January, while six-month bills were bought at a yield of 4.49%, down from 4.74%.

These lower yields are still a sign of some distress, though.

At the German auction, investors bought €4.09bn of 10-year bonds at an average yield of 1.82%, down from 1.93% a month ago. Analysts said the sale had gone “ok” – the bid-to-cover ratio (a measure of demand), rose to 1.4 from 1.3 last time [a figure above 1 means there were more orders than sales].

10.53am: Doctors and health care workers in Greece’s state sector have walked off the job today.

The strike, taking place as snow hits Athens, was prompted by the government’s latest austerity measures, demanded by Greece’s “troika” of creditors in return for more funding.

Helena Smith, our correspondent in Athens, reports:

Finance ministry sources revealed that the cuts, necessary to plug a budget shortfall of €4.4bn, will be achieved through a dramatic downsizing of public expenditure on medicines, slashing government defence spending (on which Greece spends more than practically any other EU state) and closure of
outdated state entities.

That will mean an inevitable rise in unemployment, which is already at a record high of 19.2%.

Officials have told Helena that Greece’s technocrat Prime Minister Lucas Papademos could convene a meeting of the three party leaders backing his interim administration today.

An aide said: “The prime minister is meeting troika representatives on Friday and wants to ram home the message of how urgent things are following our discussions in Brussels…..This is not going to be an easy week.”

Time is short. Athens faces €14.5bn in bond repayments on March 20. The goal is to hammer out a deal for a second package of rescue funds worth €130bn, and the private sector bond swap deal that will wipe €100bn from Greece’s debt, ready for at a Eurogroup meeting of finance ministers on Monday.

10.37am: The International Monetary Fund’s mission chief in Greece has admitted that the IMF needs to be more sensitive to the sacrifices made by the Greek population.

Poul Thomsen made a rare mea culpa in an interesting interview with the Greek daily Kathimerini, published today. He admitted that Greece’s austerity programme has “lost momentum” (after slashing GDP by 16%):

Thomsen said:

I share the frustration of many Greek officials that much of the criticism from abroad overlooks the fact that Greece has done a lot, at a great cost to the
population.

In this regard, I think that officials—myself included—need perhaps to be more sensitive to ensuring that we send a balanced signal when we say that the program is off track.

Economic modernation must be the priority, he added, rather than yet more spending cuts.

10.27am: A complete meltdown in the eurozone would cause the UK economy to shrink by 1.7% this year, and another 0.9% in 2013, according to the Institute of Fiscal Studies and Oxford Economics.

The unemployment rate would spike to 10.7%, according to Oxford Economics’ John Walker.

10.20am: Analysts from Oxford Economics, attending this morning’s Institute for Fiscal Studies briefing (which began at 10am), have predicted that the UK economy will shrink in the current quarter. That would put Britain back into recession.

Oxford Economics also warned that that eurozone crisis is casting a dark shadow over the global economy (Jess Brammar of ITN reports):

Euro crisis central to UK & global growth/slowdown. John Walker, Oxford Economics, says he’s asked abt it wherever he goes, all over world

— Jess Brammar (@jessbrammar) February 1, 2012

Jess is tweeting from the IMF event, and well worth a follow if you’re on Twitter.

10.10am: The Institute for Fiscal Studies has also warned that Britain’s austerity has barely started.

Paul Johnson, IFS director, told journalists that the UK economy has lost £200bn of output as result of the financial crisis. He explained that just £1 of every £10 of planned cuts have been achieved, and the public spending cuts have only just begun.

The scale of the cuts is unprecedented, Johnsonn added.

10.05am: Two pieces of welcome good news for George Osborne within half an hour!

Following the decent UK manufacturing data, the Institute of Fiscal Studies has just declared that the outlook for public finances over next few years is not as gloomy as official forecasts suggest.

Larry Elliott, our economic editor, is at an IFS briefing now. He says that if the IFS is right, George Osborne will have more wriggle room at next election.

It’s not all rosy — the IFS also reports that the risks to the public finances are weighted to the downside, partly because of the situation in Europe. It said

“Should the Eurozone break up, or the economy do much worse than forecast for other reasons, then future borrowing would be increased and one – or both – of the Chancellor’s fiscal targets would be broken.”

Larry reports from the briefing that:

Ed Balls will seize on the IFS finding that “the case for a significant short-term fiscal stimulus to boost the economy is stronger than it was a year ago”.

The IFS says such a stimulus wouldn’t lead to higher borrowing costs.

9.46am: The London stock market has risen higher following the news that UK manufacturing posted strong growth in January.

The FTSE 100 is now up 85 points, and the pound has crept a little higher against the US dollar to .578.

Christopher Adams, the FT’s Markets Editor, reports that traders are in riskier mood – and even rushing to buy bank shares.

Stronger than expected UK and German PMI data have given risk assets shot in the arm: banks lead gains in Euro stocks (Eurofirst up 1.2pct)

— Christopher Adams (@ChrisAdamsMKTS) February 1, 2012

9.31am: Britain’s manufacturing sector roared back to growth in January. That’s a real surprise.

Markit reported that the UK PMI came in at 52.1, which is the highest level since May 2011. City economists has expected a reading of exactly 50 (on the cusp between expansion and contraction).

Rob Dobson of Markit reckons that the strong data means that “a return to recession is by no means a certainty” (after the UK shrank in the last quarter of 2012).

The data shows that UK firms reported a jump in new orders. There were also signs that inflationary pressure is easing – with raw material costs dropping at their fastest rate since June 2009.

9.08am: The slump in Greek manufacturing output in January shows that the country is still buried deep in recession.

Markit’s senior economist, Paul Smith, warned that the country is trapped in a vicious circle, as austerity measures choke demand out of the system. With unemployment rising and consumer spending, firms are reporting that they are struggling to access working capital.

Smith said:

Until this negative feedback loop is broken, it is hard to see the fortunes of the sector improving anytime soon.

9.03am: Manufacturing output across the eurozone also fell in January, for the sixth month running.

Markit’s overall PMI came in at 48.8, up from 46.9 in December — which means that the sector kept shrinking, but at a slower pace.

While Germany returned to growth (see 8.53am), the picture in Greece was dreadful.

Greek manufacturing output slumped to just 41 on Markit’s scale, down from 42 in December. New orders took a dive, and firms also reported that their work backlogs had also dropped.

8.53am: The first European manufacturing data is in — and it’s more more good news for Germany, and bad news for many other European countries.

The German manufacturing sector returned to growth in January, with a PMI of 51 (according to data from Markit). That’s a recovery from 48.4 in December, and means Germany’s manufacturing sector expanded for the first time since September.

But French and Italian manufacturing output both declined for the six month in a row.

France’s PMI dropped to 48.5 [a reading of 50 separates expansion from contraction] from 48.9. Italy’s rose from 46.8 from 44.3, indicating that its industrial sector kept shrinking but at a slower rate.

Spain’s manufacturing sector also shrunk again, but at a slower pace (with a PMI of 45.1, up from 43.7).

Switzerland and the Czech Republic also suffered another drop in manufacturing output.

8.37am: The early manufacturing data from China has pushed European shares higher in early trading, with the FTSE 100 jumping 60 points to 5743 (up 1.1%).

8.20am: The financial secretary of Hong Kong has warned that the global economy was facing a downturn worse than the 2008 financial meltdown.

John Tsang predicted that Hong Kong’s GDP could shrink in the current financial quarter, and blamed “unresolved economic troubles” in Europe and the US and the risk of turmoil in the financial markets.

Tsang said:

Despite our resilience, we will not lower our sense of crisis.

Even if Hong Kong GDP does shrink this quarter, it is still expected to post growth of between 1% and 3% this year. Many Western countries would take that!

8.05am: Manufacturing data from China has already been released – and the picture is murky.

The official data shows that China’s factory sector expanded slightly in January, defying economists’ predictions that it would shrink. Owners reported that new orders hit a three-month high.

The official Chinese PMI came in at 50.5 in January — slightly above the 50-point threshold which separates expansion from contraction. However, a rival unofficial survey from HSBC reckoned that activity fell.

A Chinese “hard landing” would push the world economy into deeper trouble, and analysts aren’t sure how the country ‘s central bankers will respond.

As SocGen’s economist Wei Yao put it:

This presents a dilemma for the People’s Bank of China.

7.59am: Here’s a round-up of some of the main events of the day:

• French/German/eurozone manufacturing data – around 9am GMT / 10am CET
• UK manufacturing data – 9.30am GMT
• US manufacturing data – 3.00pm GMT / 10am EST

Germany auctions up to €5bn of 10-year bonds
Portugal auctions up to €1.5bn of three+six month bonds – 10.30am GMT
UK auctions £2.5bn of debt, maturing in 2025
Czech Republic auctions up to €8bn of four-year debt

+ Angela Merkel is visiting China, the IMF’s Christine Lagarde is in Tunisia

7.45am: Good morning all, and welcome to another day of rolling coverage of the eurozone financial crisis (and other related matters).

As that post-summit glow ebbs away, attention turns to the world’s manufacturing industries. It’s a big day for industrial data – showing which countries performed well last month and which struggled.

We’ll also keep a (weary) eye on Greece, where debt talks appeared to stall last night.

And it’s a big day for bond auctions – with Germany, the UK and Portugal [among others] selling debt. Will they all find willing buyers?

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