Cameron and Merkel were all smiles last week, but the PM’s pitch to Europe is a hard one to make
Amid the excruciating gags and chummy back-slapping in Berlin last week as Germany played host to David Cameron, Angela Merkel dismissed any disagreement between the two countries as “small hiccups here and there”. But with the eurozone teetering between full tax-and-spending harmony and outright collapse, Britain looks economically vulnerable and politically isolated.
Bank of England governor Sir Mervyn King expressed his frustration last month that policymakers were being forced to watch the UK’s major trading partner – Europe – “tearing itself apart”. At the Bank and the Treasury, the resolution of the turmoil on the continent is regarded as the single most important determinant of when, and how rapidly, Britain will climb out of its first double-dip recession since the 1970s.
In theory, the mooted bailout of Spain’s banking sector should have a relatively limited impact on the UK. Britain’s banks have an estimated €50bn exposure to the Spanish economy, not least through loans to Brits buying up holiday flats or retirement homes in the sun during the building boom.
However, the banks have already been encouraged by regulators to take write-downs on their Spanish assets. “Most UK banks have been pretty upfront in terms of some of their losses; they’ve been quite good in their provisioning for Spanish loans,” says Michael Derks of broker FxPro.
Meanwhile, Santander, the Spanish banking giant that took over troubled Alliance & Leicester and Bradford & Bingley in 2008, is less exposed than the regional banks or cajas that have been at the heart of Spain’s problems, and the Financial Services Authority has insisted that it ringfence sufficient assets within the UK to safeguard savers.
However, many analysts are extremely sceptical about whether a relatively circumscribed banking bailout will be enough to cauterise Spain’s economic wounds, let alone halt the eurozone’s decline into a deep recession that would inevitably depress demand, and sap confidence, for UK businesses.
“Spain is awfully close to falling into a depression: it’s had massive capital outflows over recent months. If you’re someone with money in a Spanish bank, are you going to be placated by this?” asks Derks. “This is really just the first instalment.” He believes a far larger bailout for the Spanish government will inevitably follow.
And with the Greek electorate choosing a government in a week’s time – with a far from negligible chance that the anti-austerity Syriza party will top the poll – the prospect of a “Grexit” could spark a fresh wave of market panic.
As he prepared to fly to Berlin, Cameron was full of urgent demands for action from Merkel and her colleagues – to unlock the resources of the European Central Bank and make them available to Spain and others, and to launch collective eurobonds, which could help share the financial burden around the single currency’s member states.
But the prime minister’s exhortations were never going to receive a sympathetic hearing from Merkel, who was infuriated last December when the prime minister refused to countenance the “fiscal compact” – the tough deficit rules governing euro members – being enshrined in a new European treaty.
In some ways, Cameron’s instincts are very close to Merkel’s. Both have made battling deficits via austerity the centrepiece of their policies. But that view has gone out of fashion since François Hollande came to power in France.
For the UK, the storm in the eurozone is sharpening the horns of what has long been a tough dilemma. The government needs the eurozone to succeed, because a collapse of the single currency would be catastrophic for the UK’s banking sector and the wider economy. Yet George Osborne and Cameron have both conceded that part of any workable solution to the current crisis is likely to be closer economic and financial union – something the UK wants no part of.
Unsurprisingly, the Treasury responded with a distinct lack of enthusiasm last week to the European commission’s proposals for a “banking union” that would involve a common deposit insurance fund to protect savers and the parachuting-in of European bureaucrats to run failing banks – not something King and Alistair Darling would have taken kindly to in the dark days of Britain’s financial collapse.
“Nobody suggested in 2008 that the whole of the eurozone should bail out Britain’s banks,” says a Treasury spokesman drily, going on to point out that making the case for a full-blooded single market, while steering clear of the most draconian Brussels regulations and plans for deeper political union, has always been part of Britain’s complex role in the EU.
But the frequency of clashes between London and its European partners has increased in the past 12 months, as the efforts to re-regulate the financial sector and prevent a new credit crisis have coincided with Merkel’s drive to persuade her eurozone partners to sign up to “more Europe” as part of the solution to the sovereign debt crisis.
Internal Conservative party politics have also spiced up the battles with Brussels and Berlin: Osborne’s apparent conversion to a referendum on the UK’s future role in Europe last week was seen by many as a bid to rekindle the affection of Tory backbenchers, who have deserted his cause in droves since the botched budget was followed by a series of humiliating U-turns.
“A reshaped relationship with Europe would imply, would involve, a transfer of sovereignty or powers to Brussels,” he said. “If there is any transfer of power from this country, transfer of competence or transfer of sovereignty from this country to the European Union, then there will be a referendum.”
It’s not yet clear what exactly will be the ingredients of a new eurozone settlement, or which countries will remain part of the club. But it does look likely to include closer co-ordination of tax and spending policies, and pan-European banking regulation. The worry for the government is that, over time, that will make it harder to maintain the 27-member EU as the main locus of decision-making.
No Labour government would have been any more likely to sign up for quite this much Europe either: New Labour kept the UK out of the single currency, and Westminster politicians of all stripes have long resisted handing over tax and spending powers. But trying to insist that all major decisions are made at EU level while simultaneously urging the single currency’s members to form a fiscal union may be an increasingly hard sell, not least to chancellor Merkel.
Reshaping Britain’s economic relationship with Europe in the eye of a financial storm would be rash; but whether the eurozone is destined to collapse, or to lurch towards no-holds-barred political union, the UK will be unable to escape fraught negotiations with its neighbours across the channel.
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