Eurozone troubles may derail recovery in UK warns Bank

An increase in economic problems in the periphery of the eurozone could "derail" the UK's nascent recovery, the Bank of England's deputy governor has warned.

In a speech in London, Charles Bean said that while the euro area as a whole appeared to be undergoing a steady recovery, closer examination revealed differing performance and prospects between members.

He said: "Germany is growing rapidly, led in part by an expansion in exports to the booming Asian economies. The countries of the periphery are, however, struggling in the face of significant fiscal and structural challenges. While each of the countries of the euro-area periphery are each confronted by specific challenges, they all need to restore their competitiveness without the option of devaluation."

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Mr Bean said that bailouts for Greece and Ireland from the International Monetary Fund and the rest of the European Union had given struggling countries some breathing space.

He added: "Financial support for other countries may or may not prove necessary – only time will tell. But the important thing for us is whether an intensification of the difficulties in the euro-area periphery could also derail the recovery here.

"Sharp fiscal consolidation and very slow growth in the periphery countries would, of course, have some adverse impact on the demand for our exports. But the more significant links are potentially through the financial system.

"Fortunately, UK banks have done much to improve their resilience over the past couple of years and, even under a very adverse scenario, they should be able to absorb the losses on their direct exposures to Greece, Ireland, Portugal and Spain without too much difficulty. There is, though, the possibility of further indirect effects arising through the interconnectedness and cross-border operations of European banks which could amplify the impact. So some adverse effect on the funding costs of UK banks and the supply of credit remains a possibility."

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This could have a deeper impact, said Mr Bean. He added: "Harder to gauge is the potential effect on household and, especially, business confidence. In the aftermath of the collapse of Lehman Brothers, this was arguably the most significant transmission channel to the real economy.

"An intensification of the sovereign debt problems in the euro area could therefore administer a blow to the recovery here. But given the very high degree of uncertainty, there is little that the Monetary Policy Committee can do to deal with this risk ahead of crystallisation."

Mr Bean said it was certainly possible the central bank would want to do a second round of quantitative easing if there were clear signs that growth was slowing.

On a more upbeat note, he said: "As 2010 draws to a close, the good news, then, is that the recovery here and more widely has remained on track, following the sharpest downturn in activity since the Great Depression. Such an outcome was by no means guaranteed 12 months ago; for that we must be grateful."

Challenges ahead include a financial system overly reliant on official support, fragile household and business confidence, bloated public sector deficits and global inflationary pressures, he added.