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Philip Hammond, the Chancellor of the Exchequer, must know the old warning that people in glass houses should avoid throwing stones. But he seems to have forgotten it on his recent trip to Germany, dubbed by the British press a “charm offensive,” ahead of looming Brexit trade negotiations. If this was charm Mr Hammond clearly went to the wrong finishing school.
For Hammond chose to threaten his hosts with “financial instability” in Europe if they do not help Britain come up with a financial sector trade deal which will underpin the City of London’s current role as Europe’s “Wall Street,” the dominant market for issuing and trading euro currency denominated securities.
Unsurprisingly this did not go down well with his hosts.
As Graham Bishop, a leading expert in European financial market regulation points out, in reality the boot is on the other foot. A breakdown in Brexit talks on the future of the City’s role as a centre for euro currency financial services business will certainly be damaging banks on both sides of the channel. “But it will be the British economy which will suffer worse,” Bishop says. There are several reasons for this.
One is that, as the International Monetary Fund pointed out in its so-called Article IV review of the British economy just before Christmas, no European economy has a financial sector which is as big and important to its economy as Britain’s.
“The financial sector, which represents about 7 percent of GDP but accounts for around 10 percent of tax revenues and 14 percent of exports, may be particularly affected in the absence of an agreement that allows the majority of EU-facing financial services currently provided from the UK to remain there,” the IMF warned.
Behind this judgement is the harsh reality that it is much harder to cope with a severe financial crisis is you are a country with a giant financial sector, like the UK, but only a medium sized economy to support it. Wall Street’s recovery from the 2007/8 financial meltdown was helped by the continental sized US economy underpinning it.
The IMF’s Managing Director, Christine Lagarde, gently pointed out, at a press conference at the UK Treasury in London that far from being misleading -as Brexiteers argue – the IMF’s warnings before the referendum in June 2016 that Brexit would, in time, damage the UK economy, are now coming true (“Gloomy Brexit forecasts are coming true says IMF.”)
Growth is indeed now slowing, consumption is weakening as inflation erodes consumer incomes, and investment and exports are not filling the hole. This is not surprising as household expenditure accounts for around 60% of gross domestic product.
In both the Euro area and the United States, by contrast, growth is accelerating. Led by a booming Germany, the Euro area economy is at last recovering strongly, with unemployment dropping to its lowest level for nine years.
The minutes of the European Central Bank’s meeting in December published last week have even dropped the reference to economic “recovery.” They describe the economic expansion as “robust and increasingly self-sustaining.” They even hinted at a sooner than currently anticipated tightening of monetary policy and rising interest rates.
In the United States too, where the economic upswing is entering its ninth year, there are growing fears of a looming stock and financial market bubble as economic growth strengthens further and President Trump’s ill-timed and targeted tax cuts kick in.
New York Federal Reserve Board President William Dudley indicating recently that, in the US too, interest rates may need to move up more swiftly now than markets have been anticipating. (“Fed’s Dudley says tax cuts lift prospect of rate rise.” )
A year ago (February 2017) the International Regulatory Strategy Group, the top City committee working on Brexit financial sector issues, was warning that “in order to avoid financial instability and disruption to the operations of markets” a transition deal for the financial sector was urgently needed.
There is still no deal today and if anything negotiations to secure the City’s future in Europe have moved backwards in the past twelve months says Graham Bishop.
Meanwhile, stronger growth in Europe and the US, rising dollar and euro area interest rates at a time when the UK’s economic fortunes are flagging mean rate rises not on the Bank of England’s agenda.
When coupled with political uncertainties surrounding a divided British Cabinet this combination of economic and political instability is a recipe for trouble in the UK’s financial markets.
Mr Hammond needs to stop throwing stones and warning about the risks of financial instability and find a way out of the glass house he is occupying or he will discover that the biggest loser from renewed financial turmoil will be the United Kingdom.