Eurozone Deal Won’t Stop Growth Taking a Hit

It was 1993, and Kenneth Clarke, the justice secretary, was chancellor. In the year after Britain’s humiliating exit from the European exchange rate mechanism (ERM), the system was on the point of collapse.

But Clarke, at a meeting of EU finance ministers, told them to pull themselves together and press ahead with monetary integration. The rest is history, though some would say Europe would be a lot better off if he had kept quiet.

Times have changed. These days EU leaders would never take advice from a British chancellor or prime minister.

That is partly because of their inexperience, partly the Tory attitudes towards Europe revealed in Monday’s Commons vote. But also because any goodwill towards Britain was lost in the years when Gordon Brown lectured them on how to run their economies.

So George Osborne and David Cameron were left wringing their hands and calling for something to be done. They are also left bemoaning the eurozone’s corrosive effect on Britain’s recovery. Are they right to do so, or are they covering for Britain’s home-grown problems? Has Europe done enough?

As it turned out, eurozone leaders came up with a version of the “grand plan” that has been circulating for some weeks and the markets, initially at least, liked it.

Whether intended or not, this was a good example of expectations management. Ahead of the meeting there were fears of no deal at all (though there always is).

The result, a beefing up of the European Financial Stability Facility (EFSF) to ¤1 trillion (£880 billion), a ¤106 billion (£93 billion) recapitalisation of European (but not British) banks and voluntary 50% haircuts on Greek debt, did enough to reassure.

Plenty of doubts remain, particularly over Greece and Italy, and over the details. The markets were perhaps a little too euphoric. The eurozone has been the biggest threat to the recovery, globally and in Britain. If there was an easy way out, the Next chairman Lord Wolfson would quickly be relieved of his £250,000 prize.

Time, however, is a valuable commodity. And the EU has bought it. Has it removed the threat to the rest of us?

Much of the sharp drop in business and financial market sentiment in the past few weeks can be laid at the door of Europe’s difficulties.

The CBI’s very gloomy industrial trends survey, published a few days ago, recorded the sharpest drop in business confidence since 2009, when the economy was in recession, and showed manufacturers expect a drop in output this quarter.

According to Ian McCafferty, the CBI’s chief economic adviser, confidence is “being sapped by uncertainty over developments in the eurozone, leading to broader concerns over global growth.”

If CBI members’ expectations of a drop in output in the current quarter turns into a generalised fall in economic activity, the drop in GDP that the monetary policy committee’s Martin Weale and Paul Fisher fear, the eurozone will be the proximate cause.

Despite the eurozone agreement reached in the early hours of Thursday morning. the downturn in the fourth quarter, certainly in the eurozone, possibly in Britain, is already baked in.

Both of the expected drivers of recovery, exports and business investment, have been affected by the eurozone’s problems. Investment has been undermined by fears of what the crisis might bring, while the sharp slowing in Britain’s biggest export market is taking its toll on trade.

Purchasing managers’ surveys for the euro area are this month below the key 50 level for the second month in succession, pointing to its economy being back in recession in the final quarter, which links directly to the pessimism among Britain’s manufacturers.

It is not all bad news on the trade front. Though export growth is slowing, the trade gap is also narrowing. In August it was £1.9 billion, just over half its level a year earlier. And, while not wanting to jinx it having some time ago predicted a return to current account surplus, the latest figures were also encouraging.

The Office for National Statistics is in one of its dramatic revision phases. As I have said before, this makes much of its data useless for short-term economic management. So we thought we had a current account deficit of £9.4 billion in the first quarter but that has now been revised down to £4.1 billion.

The second quarter deficit, £2 billion, was just 0.5% of gross domestic product. One difference between Britain and the problem hit countries of the eurozone is the absence of a serious current account problem. Greece had a deficit of more than 10% of GDP last year, while Portugal’s was just under 10%. Italy is on course for a deficit of more than 4% of GDP this year.

It would be wrong, however, to blame all Britain’s woes on the eurozone. Though consumer confidence has been pummelled, it would be unusual if British households were responding directly to events even as close as the other side of the Channel by reining back spending.

Thanks to the ONS’s revised numbers, we now have some rather different information on Britain’s households. This year was supposed to be the second in a row real household disposable incomes had fallen. But the new figures show, rather than falling by 0.8% last year, real incomes edged up by 0.1%.

The numbers do not change the broad picture of households not increasing spending in real terms. This, of course, has less to do with eurozone woes than high inflation, rising taxes and fear of unemployment, partly because of spending cuts.

But the ONS’s new numbers do show the previous picture – of consumers not spending but not saving either – was incorrect. The saving ratio in 2009 was revised up from 6% to 7.8%, while the ratio for 2010 is now put at 7.5%, up from 5.3%. In the latest quarter, the saving ratio was 7.4%.

What this tells me is that there is potential for a recovery in consumer spending, which after all is weaker at this stage of the cycle than in any previous episode. Consumers have quietly been putting their finances back into shape. When conditions are right they will spend more. Whether they will do so in time to make up for the shortfall in exports and business investment is the big question.

My regular column is available to subscribers on This is an excerpt.

This post originally appeared at David Smith’s EconomicsUK and is reproduced with permission.