When the EU and the International Monetary Fund (and Germany) spent €110 billion to dig Greece out of its deep fiscal hole six months ago it looked for a while as though Brussels’ shock-and-awe tactic had done the job. The EU would stand behind ailing members of the euro zone to the full extent of its collectively deep pocket so there was no need for investors to worry that any other country would be in danger of defaulting on its government bonds. For a while it did work. As recently as a month ago there was no real threat of the contagion that investors had previously worried about. The major concern at the end of October was that government spending cuts in Britain would plunge the economy back into a combination of recession and renewed quantitative easing by the Bank of England “(printing money”, as the programme’s detractors referred to it). Since then there has been a reversal of those worries.
In November it quickly became apparent that the confidence created by the Greek bailout was no more than skin-deep. Investors started to worry about Ireland in the same way they had worried about Greece: If they bought Irish government bonds, would they get their money back? They started to demand a higher rate of interest on loans to the Irish government, in the same way that banks offer more favourable lending rates to international conglomerates than they do to pie and mash shops in Wigan. Ireland was embarrassed, but not particularly worried by what it saw as a temporary glitch. After all, it did not need to go to the market for any new money until June next year.
But it soon became clear this was not a temporary problem. It was fundamental. Investors would probably not be lining up to buy the Irish government’s next bond issue. Somebody had to do something and the only somebody with sufficiently deep pockets and generous intentions was the European Financial Stability Fund. Ireland’s government initially denied it needed assistance, just as the Greek government had made a similar denial in April and May. Eventually though, Dublin did its duty, accepting the bailout money to avoid the risk of a contagious loss of confidence spreading to other countries on the periphery of the euro zone. Just as Athens had made the same decision, for the same reason, six months earlier.
So will it work? At the moment it does not look good. Investors’ concern has already moved on to Portugal, and Spain looms large on the radar. Belgium and Italy are up for grabs as another two fiscally failing states. The vultures are circling. The president of Germany’s Bundesbank says “We’ll do everything to safeguard the existence of the euro”. It was a reassuring statement from the chap tipped to head the European Central Bank next year. But is it just the teensiest bit worrying that he felt the need to say it?
As the cracks spread through the weaker members or Euroland, Britain’s economy continues to confound its detractors. Gross domestic product grew by 0.8% in the third quarter of the year. The number of jobseekers went down in October, not up as most analysts had predicted. Inflation sits at 3.2% and will be above its 2% target for at least another year according to the Bank of England. If those indicators are anything to go by, a second round of quantitative easing is off the agenda.
Sterling’s recent progress has come partly as a result of Britain’s relative economic success and partly because of spreading fiscal cracks in the periphery of the euro zone. Both situations could change. Higher unemployment and slower growth in Britain are a real possibility. The EU could nip its confidence problem in the bud, bringing buyers rushing back to Portuguese and Spanish government bonds. In the meantime, however, the currency gods favour the pound over the euro, even if they are not giving it the full force of their assistance.