EXCLUSIVE: Warnings over second credit crunch coming

Robyn Hall

November 10, 2011

The threat of Italy defaulting on its debts reached such dangerous levels yesterday that three-month Libor (London Inter-Bank Offered Rate) – the interest rate that banks lend to each other – reached 1% for the first time since July 2009.

Under normal circumstances the spread between LIBOR and Bank of England base rate is between 0.15% and 0.2% but the gap soaring to 0.5% is a warning bell that banks are running scared of a second financial meltdown.

Ray Boulger, senior technical director at John Charcol, said: “Libor at 1% is a key psychological level. It has been slowly but remorselessly rising throughout the past few weeks, and it means that lenders will be much more cautious about offering good tracker rates.

“The banks got caught out last time when they were offering loans at base rate plus 0.5% or less, which were in reality funded through Libor.

“We’ve already seen Yorkshire building society put up its two-year tracker rates by 0.2%, and things could get nasty more quickly than anyone envisaged even a few days ago. We are rapidly getting to the point where markets are simply taking over.”

Gary Styles, risk and economics director at Hometrack, said his forecast for growth next year had shifted since the beginning of the week when he thought GDP growth in 2012 would be an anaemic 1.2% to 1.3%.

He said: “All bets are now off. I’m under no illusions about attaching probabilities to that. House prices falling next year and the year after is likely but if we’re talking about Italy defaulting then house prices in the UK will fall 10% or more very short term.”

Speaking at a Mortgage Introducer roundtable this morning Rob Thomas, senior policy adviser at the Council of Mortgage Lenders, said there are two solutions to the escalating problems in Europe.

Either the eurozone embraces full fiscal union or the European Central Bank, which has unlimited firepower in the Euro, steps in and monetises most of Italy’s debt.

He claimed this would reassure markets and push the cost of sovereign borrowing back down to sustainable levels. Yesterday Italian 10-year yields hit euro-era highs of 7.48% and no European country has so far breached the 7% threshold without needing a bailout.

Thomas said: “There are no solvency issues for the ECB. If you print currency you can print as much as you like. The Germans hate the idea because of the risk of inflation but we have printed close to £300bn through quantitative easing in the UK and it is not causing too much inflation here.”

Thomas said unless the ECB took this path “very soon” there would be devastation in the UK.

He added: “The UK cannot insulate itself against a big event in the eurozone at all. It will have devastating effects, particularly a country leaving the eurozone because there is no clear legal mechanism to do that – it would be chaotic. QE may ultimately be the only viable solution.”

Gary Styles went further claiming he could see a scenario where Italy and Greece had to leave the euro altogether.

He said: “The muddle through scenario the eurozone had been planning on is unravelling. The gradual recovery scenario that looked possible just six months ago is fading.

“The most likely outcome is looking like we muddle through for a little while but we are going to end up with a Euro break up by the looks of it.”

And Fionnuala Earley, UK consumer economist at RBS, said: “The longer this goes on for the worse it gets and the worse confidence gets. The ECB needs to throw lots and lots of money at it in the shock and awe vein so that people feel there is no possibility of default.”

But Tony Ward, chief executive of Home Funding, did not share this view.

He said: “Traders love volatility and uncertainty and they will continue to drive that market down. I don’t think even the ECB can withstand the market. It’s just vast. The flaw with the eurozone was always not having full political, fiscal and monetary union. It has to be that otherwise it’s doomed to fail.”

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