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George’s balancing act

The chancellor’s biggest issue is the one over which he has least influence - the eurozone debt debacle

IT IS unlikely that the chancellor had a particularly merry Christmas. In his Autumn Statement, he had to mark down his own growth forecast for 2012 to just 0.7%, weaker even than the disappointing rate for last year. Unemployment will be higher than he had expected in the spring Budget and, as a result, the date by which he will achieve his fiscal ambition now stretches into the next Parliament. This is not where the UK should be in the third year of recovery.

Among the problems that continue to bedevil activity is a nervous household sector struggling with debt, coping with inflation running ahead of earnings growth and seeing a higher proportion of squeezed incomes going in higher taxes. As if that was not enough, there are ongoing fears in many sectors about job security. With the public sector effectively ring-fenced as far as growth is concerned, there is little incentive for firms to spend the cash pile that has built up on investment. The domestic economy is therefore treading water, and time more than anything is needed to correct the imbalances.

But probably the biggest issue is the one over which the chancellor has least influence – the never-ending eurozone debt debacle. Although the crisis has apparently subsided after the drama of the December summit, this is just another false dawn. It is likely that 2012 will be a crunch year for the currency and the European economies. The working assumption for most policymakers is that the euro survives, but for all the hype that followed the Brussels meeting, financial markets remain unconvinced and more turbulence is ahead before a solution is reached.

The eurozone faces challenges on several fronts. First, sovereign and bank financing needs are heavily frontloaded. In the first half of this year, for example, Germany, France and Italy will have to raise £1.5tn. Second is the need for national parliaments to ratify the legislation agreed in Brussels, with the possibility of a referendum or two, the outcome of which cannot be taken for granted. Next is the rating agency downgrades of nine eurozone member states, which came as a major financial and political blow for the architects of the December package.

There is, however, an even bigger task which hardly featured in the Brussels discussions. Correcting the imbalances between the members of the eurozone is vital, and this issue was brought into sharp focus in the first week of 2012. It was reported that the German unemployment rate (6.8%) fell to its lowest level since reunification 21 years ago while in Spain, the jobless total climbed to 21.5% of the labour force. To reduce unemployment, and to fund the debt, at higher borrowing costs, Europe needs economic growth. But the fiscal retrenchment needed to bring public finances back within the fiscal rules is pushing many countries into recession. Countries, like companies, rarely shrink to greatness and the repayment arithmetic looks frightening for many countries. Convergence will have to wait.

A big step to help the weaker countries close the gap would be for the creditor nations, such as Germany, to bolster their domestic demand to help the periphery’s export growth. Since these countries cannot devalue their currency, this would be a way of regaining competitiveness. But again, a likely recession in 2012 is blocking off this option. Unless there is genuine convergence of economic performance, some countries will be condemned to permanent areas of relative poverty dependent on rescue packages from their wealthier partners.

So, there are a lot more bumps in the road to negotiate before the eurozone is sorted. The resulting uncertainty will compound the problems for the UK but there is little the government can do but wait and see. ?


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