RESOLUTION OF GREEK DEBT CRISIS IS KEY

UK BRANCH MANAGER, EASY-FOREX

IS THE Greek debt restructuring a turning point in the EU debt crisis? Despite the announcement of a Greek debt restructuring, the country's debt woes are far from resolved. Even with the successful debt swap, the Greek debt burden will remain above 120 per cent of gross domestic product, which the IMF considers unsustainable. The Greek economy continues to weaken. As austerity measures kick in, the economy may experience more rapid weakening. This presents a challenging backdrop ahead of Greek elections to be held in April or May. Polls indicate that those in opposition to mandated austerity measures are leading. The election could result in the formation of a new government that rejects adherence to the demand for Greek austerity. If the new government rejects the bailout terms, Greek debt will have to be restructured again. Some have argued that within a year, another restructuring is inevitable. All Greece has done is buy time.

The debt swap forced private sector bondholders to take a substantial loss and this could shatter trust in the EU bond markets. Some bondholders may take legal action challenging the conditions of the debt swap – which could further erode confidence in EU bonds. Bond yields dipped in Spain and Italy after the announcement of the debt swap but rose in Portugal. Some are now asking whether Portugal is the next weakest link and EU country at risk of a debt default.

So what does this mean for the UK economy and sterling? Around 50 per cent of UK trade is with the EU, and austerity measures and possible broadening of an EU credit crunch increases the risk of an EU and UK recession. Although the UK has limited debt exposure to Greece, European banks will face large losses if Greece needs future bailouts and Portugal needs debt relief. EU banks will have less money to lend which could result in reduced trade between the UK and EU. UK industrial and manufacturing production has been weak. This may force the Bank of England to expand quantitative easing, which may be a moderate short-term negative for sterling. The currency may see additional selling as Greek debt swap euphoria fades and focus shifts to Portugal and Spain.