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News : UK Economy Last Updated: Aug 2, 2011 - 10:21 AM

UK banks' direct exposure to debt of struggling Eurozone economies could trigger "substantial contractionary shock"
By Finfacts Team
Aug 2, 2011 - 8:51 AM

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UK banks' direct exposure to the sovereign debt of struggling Eurozone economies is "manageable," but if big European banks are impacted directly by the crisis, the UK could experience a "substantial contractionary shock," the International Monetary Fund (IMF) warned Monday.

In its annual health check of the UK economy, the IMF reaffirmed its support for the British government's fiscal adjustment program and the Bank of England's decision to keep its key interest rate at a record low of 0.5%. The Fund said the economy should start to grow again with GDP (gross domestic product) expanding 1.5% this year and 2.5% annually from 2012.

However, the Fund warned that developments in the Eurozone are a "key risk" to that outlook. It estimates that UK banks are owed a total of $178bn by Greek, Irish and Portuguese borrowers, of which Irish borrowers account for $135bn. That's equivalent to 25% of UK banks' capital.

The IMF said the UK economy would be in peril if the problems of the Eurozone's peripheral countries repaying their debts were to lead to "stresses" among major European banks, or a disruption in the international markets in which banks fund themselves.

"Such a combination of forces could set off an adverse and self-reinforcing cycle of high bank losses and funding costs, tighter credit, lower consumer confidence and exports, and falling real estate prices, resulting in a substantial contractionary shock," the IMF said.

"The IMF is expecting a bumpy and uneven recovery in the U.K. and our updated growth forecast for the near term, taking into account the recent GDP release for the second quarter, will be published with the September World Economic Outlook. Over the medium term, we expect growth to accelerate gradually to about 2½%," Ajai Chopra, IMF mission chief, said on Monday. "But volatile commodity prices, the uncertain magnitude of fiscal headwinds, and problems in the Eurozone have added a lot of uncertainty to this outlook. It’s not easy to steer a clear course in such circumstances."

IMF report on UK (pdf)

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