Britain Grapples With Debt of Greek Proportions
By LANDON THOMAS Jr.
Without a strong political majority to tackle Britain’s lumbering fiscal problems, the stage could be set for a potential double-dip recession, if not worse.
LONDON — As Greece’s debt troubles batter the euro, Britain has done its utmost to stay above the fray.
Until now, that is. Suddenly, investors are asking if Britain may soon face its own sovereign debt crisis if the government fails to slash its growing budget deficits quickly enough to escape the contagious fears of financial markets.
The pound fell to $1.4954 on Tuesday, its lowest level against the dollar in nearly 10 months. The yield on 10-year government bonds, known as gilts, slid as investors fretted that Parliament would be too fragmented after a crucial election in May to whip Britain’s messy finances back into shape.
The slide in the pound followed a sharper decline on Monday after polls released over the weekend indicated that the opposition Conservatives had lost their clear lead in the election race.
Without a strong political majority to tackle Britain’s lumbering fiscal problems, investors could start to make it greatly more expensive for the government to raise funds, setting the stage for a potential double-dip recession, if not worse.
“If you really want a fiscal problem, look at the U.K.,” said Mark Schofield, a fixed-income strategist at Citigroup. “In Europe, the average deficit is about 6 percent of G.D.P. and in the U.K. it’s 12 percent. It is only just beginning.”
Since the Labour government’s intense fiscal intervention in 2008 and 2009, yields on British government debt have soared to among the highest in Europe. And on a broader scale, which includes the borrowing of households and companies, the overall level of debt in Britain is the second-largest in the world, after Japan’s, at 380 percent of the country’s gross domestic product, according to a recent report by the consulting company McKinsey.
In recent weeks, the focus has been on debt scofflaws in Europe like Greece, Portugal and Spain, countries where borrowing costs have shot up in line with their growing deficits as investors demanded higher rates to compensate them for the added risk of lending the governments money.
But the recent plunge in the value of the pound below $1.50 and the gradual move upward of Britain’s benchmark 10-year borrowing rate on gilts to above 4 percent suggest that investors are now getting ready to reassess the country’s fiscal condition.
Britain is not in the 16-nation euro zone and, unlike Greece and other struggling countries that use the currency, it retains control over its monetary policy. As a result, it has benefited so far from a huge bond-buying program undertaken by the Bank of England — proportionally, the largest in the world — that has kept mortgage rates and gilt yields at unusually low levels.
That means the government and its citizens have been able to continue to borrow at interest rates that do not reflect their true financial situation.
Indeed, the increase in private and government debt here contrasts sharply with the deleveraging that has been going on in the United States.
British household debt is now 170 percent of overall annual income, compared with 130 percent in the United States. In an echo of the United States’ rush into subprime mortgages with low teaser rates, millions of homeowners in Britain have piled into variable-rate mortgages that are linked to the rock-bottom base rate.
As for the British government, it has been able to finance a budget deficit of 12.5 percent of G.D.P. — equal to Greece’s — at an interest rate more than two full percentage points lower only because the Bank of England bought the majority of the bonds it issued last year.
“It’s not just ‘basket cases’ like Greece that can be considered candidates for sovereign crises,” said Simon White of Variant Perception, a research house in London that caters to hedge funds and wealthy individuals. “Gilts and sterling will continue to come under pressure as scrutiny of the U.K. fiscal situation intensifies.”
Adding to this concern is the precarious condition of the British consumer. As interest rates have hit new lows, the popularity of variable-rate loans has grown. At the end of December, 40 percent of new mortgages were tracking the government’s base rate.
Despite comments from Mervyn King, the governor of the Bank of England, that he might restart his quantitative easing program in light of current economic weakness, the view among investors is growing that interest rates here will rise further, along with higher inflation and Britain’s increased risk profile.
In a speech this year, Andrew Haldane, the executive director of financial stability at the Bank of England, warned about how vulnerable Britain was to a rate increase, pointing out that an increase of one percentage point would cause debt service costs relative to income to double, to 13 percent.
“This is a ticking time bomb,” said Nick Hopkinson of Property Portfolio Rescue, a company that assists overleveraged homeowners. “There are over 400,000 people who are in arrears with their mortgage rates the cheapest they have ever been. When rates increase, a lot of people will be tipped over the edge.”
As a result, those counting on the British consumer to take up the slack from any scaling back of government borrowing could be in for a shock. Consider Sheridan King, a sales manager who is struggling to pay off his £32,000 ($47,075) in nonmortgage debt. Far from thinking about going shopping, his first priority is keeping clear of his creditors.
And even though his variable mortgage of about £100,000 carries a very low rate, interest costs are already chewing up a substantial portion of his pay, and he is deeply worried about the future.
“If rates go up, it will be a very dangerous situation for me,” Mr. King said. “It might lead me to consider bankruptcy.”
For the time being, at least, the British government faces no such threat.
Despite its borrowing and spending excesses, Britain still maintains a triple-A credit rating and much of its debt is long term. But with 29 percent of British bonds held by foreigners, Britain, like Greece, remains highly vulnerable to the vicissitudes of outside investors.
Since early this year, foreign holdings of British bonds have fallen from 35 percent, a trend that has tracked the pound’s decline and contributed to the increase in the yield on its 10-year gilts.
As to which political party he thinks is best placed to handle these challenges, Mr. King takes a skeptical view. “We are just struggling to get by with all this debt,” he said. “It’s time the government got its house in order.”