Blimey – what a week that was. Between them, Greece and the UK have been dragging me in all directions over the past seven days – with more than one sneaky politician trying to make the link between the two. But, just because the UK's deficit will be bigger than Greece's this year, should we be worried?Greece, for sure, is now looking into the abyss. Following weeks of prevarication, mutterings and blatant obstruction by the German government, S&P finally lost patience and downgraded Greek debt to junk status. And Moody's, which still has a relatively high-looking rating for Greek debt at the moment, warned that it too may soon follow suit.
Greece's problems are two-fold. First, it owes a lot of people a lot of money, not least because the previous government, kicked out last year, simply lied about its finances. But the second factor – the reluctant Ms Merkel – has not really been its doing. Euro area leaders could have killed this story three months ago with a strong show of support for the Hellenic Republic. But they did not – and the European authorities demonstrated, once again, that they completely fail to understand financial markets. Investors do not stand still while you are busy umm-ing and ah-ing: the market moves on, and dynamics quickly take over.
As a result, financial markets are now completely shut to Greece: it is entirely reliant on outside help. And with (almost) everyone keen to avoid a debt restructuring – a polite euphemism for default – the Euro area may well have to stump up over â‚¬100bn, together with extra money from the IMF, in order to give Greece a safe haven. Unfortunately, all the package will do is buy Greece time – and the â‚¬300bn question is whether the package buys enough for Greece to regain market confidence, and be able to issue debt again. That is far from certain. And, just to make things worse, even if the Germans do vote to release the first tranche of funds this week, worryingly there is no guarantee that they will not change their minds by the time the next instalment is due.
Just like swine flu, fears about Greece have been spreading among the rest of the PIIGS, with Portugal, Ireland, Spain and Italy all seeing their cost of borrowing rise this week. Portugal was worst hit, after S&P – them again, trying to catch up after ballsing up on Iceland – downgraded it two notches to A-, the equivalent rating that Moody's has for Greece*. German yields, in contrast, fell – as even if the Euro collapses, everybody thinks the Germans will keep their mantle of austerity. They are the benchmark 'safe bet' in the euro area.
What about the UK? Well, interestingly, UK yields did not go up this week, like those of the PIIGS. Instead, gilt yields fell, following German rates lower. This clearly indicates that investors still regard the UK as a safe bet too, despite the prospect of a hung parliament looming. And that is because, although our deficit may be bigger this year, just about every other aspect of the UK economy is brighter than in Greece. The UK may only have crawled out of recession – but Greece is still in one, which is about to get worse, and unemployment in the Mediterranean could remain higher than in the UK for at least as long as it took Odysseus to get home. The UK also has its own currency, which happily already fell sharply during 2008, regaining competitiveness the easy way, rather than forcing painful wage and price cuts on the economy, a la Greece. The UK debt stock is also much lower – and, if push really came to shove, the BoE is already pretty experienced at hoovering up gilts. The ECB, in contrast, would probably never countenance such a measure, even if it was guaranteed to stop the whole of Europe sinking without a trace like Atlantis.
In short, do not worry too much about the deficit here. Yes, it is big. And yes, the cuts that we will see may need to be so painful that this really is a good election to lose, unless you then want to be out of power for a long time. But all parties are committed to cutting borrowing and, while the UK is far from the US, it is still a relatively flexible and competitive economy by European standards. No-one should expect a great British recovery, for sure – but just pop over to Athens if you really want to see how much worse things are elsewhere. Provided, of course, you'd rather have the truth instead of a snazzy headline.
* Correct as of 14.37:23 on Friday 30 April.