Eurozone Crisis Outcomes Laid Out

Michelle Remo, “Big 4″ observer
December 05, 2011 /

The Eurozone crisis may result next year in the monetary expansion through a liquidity injection from the European Central Bank, orderly defaults for the most indebted countries, Greek exit and a new currency bloc, according to a PwC report.

The report analyses each of these scenarios and outlines the outcomes of each in terms of the potential Eurozone inflation and GDP impact from 2012 until 2016.

With the monetary expansion, the European Central Bank is given the go ahead to inject significant liquidity to vulnerable economies. Recession is avoided, interest rates are kept low in the short term, but inflation rises well above its target of 2 percent, while the euro depreciates.

Regarding the orderly defaults, a programme of voluntary defaults is agreed for the most indebted countries, which triggers a contractionary debt spiral and a prolonged recession, lasting between two and three years, and which results in a cumulative loss in GDP of around 5 percent in Eurozone.

The Greek exit scenario projects Greece as being compelled to leave the Eurozone, and then suffers a sharp deterioration in its economy, a rapid depreciation of its new currency and an inflation spike. The Eurozone seeks to protect its currency through tough fiscal discipline and other investor confidence increasing measures, but still suffers a recession that lasts up to two years.

PwC also outlines a new currency bloc. A Franco-German acknowledgement that the existing Eurozone is unsustainable paves the way for a new, smaller and more tightly regulated currency bloc.

The ‘new-euro’ would be expected to appreciate dramatically and for the new bloc to benefit from a boom in domestic demand. Economies that are excluded suffer a sharp currency depreciation and severe economic contraction.

“We expect these scenarios could have an impact well beyond the Eurozone. Countries like the UK and US are likely to see falls in exports and banking sector problems but possibly also increased levels of capital inflows, as investors look to place a larger proportion of their portfolios in ‘safe haven’ markets. Other countries, like China, will have to deal with a decline in a significant proportion of their export markets,” Yael Selfin, head of macro-consulting and a director in PwC’s economics team, said.

“Orderly defaults by the most indebted countries, a Greek exit, or strong monetary expansion in Eurozone are likely to highlight the UK’s position as a safe haven for capital. Capital flows out of the Eurozone and into the UK would cause sterling to appreciate against the euro. Borrowing costs may well be lower as investors purchase UK gilts in preference to risky Eurozone bonds,” Selfin added.

“However the UK’s principal trading partner is the Eurozone which is the destination for around 50% of its exports. A relatively strong sterling and a recession in the Eurozone would weigh down on the UK’s growth prospects.”


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