The Euro zone debt crisis has unashamedly hugged the limelight for a while now. It has been a storm swirling over Europe for the last couple of years with hardly any respite. It has consumed governments in Italy, Spain, Greece, and Ireland and to an extent France.
The markets have been spooked by the renewed threat of a Greek exit from the euro as a result of the recently concluded but inconclusive elections and this has affected the borrowing costs across board including countries that are not suffering from the debt overhang.
Latest figures show that that 10 year borrowing costs have soared for governments in the eye of the storm and the likes of UK, Germany and the US have seen borrowing costs fall to record lows as a result of flight to safety by investors fleeing risk assets. Greece, Spain and Italy currently have yields of 30.1%, 6.7% and 5.9% on their 10 year debts respectively, while the UK, the US and Germany have seen yields plummet to 1.7%, 1.6% and 1.3% respectively.
From a hitherto united front in tackling the debt crisis led by the famed Merkozy alliance; to an increasingly divided policy response. Questions are now being asked about the possibility of issuing Eurobonds, the wisdom of austerity measures and a more profound role for the ECB. Three months ago, these were only whispered with caution. The proponents of such measures have now been emboldened by the election of Francois Hollande and the election results in Greece. The storm is suddenly becoming a hurricane. There are now genuine fears for the future of the single currency.
Over the coming months, twists and turns are expected. Will we see the re-introduction of the Drachma? Can Greece remain in the Euro zone if they do not meet their commitments, will there be financial armageddon if there is a disorderly exit of any Euro zone country from the single currency? How much longer will Merkel hold out and insist on the fiscal compact and the terms of all the bailouts? Number crunching is unlikely to answer these questions with a reasonable level of confidence or certainty.
But what number crunching can answer with a reasonable level of confidence is what impact is the debt crisis having on the Greeks, Spanish and the Italians that we see so many protests on our TV screens?
Let us devise a hypothetical example where an average UK household is faced with Spanish/Italian/Greek style interest rates on mortgages.
The average UK mortgage depending on who you believe is between £110,000 and £130,000. For the purposes of this calculation, we will adopt the mid-point of £120,000. We will also use the Bank of England calculated average mortgage rate of 3.6%. This equates to a premium of 2.03% over the UK’s current 10 year borrowing rate. This premium will be applied to the borrowing rates of the aforementioned countries to extrapolate an average mortgage rate.
On the basis of perceptions of risks of borrowers remaining the same and funds available at the same rate, what will the monthly repayment on a mortgage of a typical UK family with an average of 10 years term remaining on their mortgage?
- A typical UK family subjected to the average UK rate of 3.6% on a £120,000 loan outstanding and a term of 10 years will pay £1,200 per month.
- A typical UK family subjected to the hypothetical but extrapolated Italian rate of 7.97% on a £120,000 loan outstanding and a term of 10 years will pay £1,489 per month.
- A typical UK family subjected to the hypothetical but extrapolated Spanish rate of 7.97% on a £120,000 loan outstanding and a term of 10 years will pay £1,537 per month.
- A typical UK family subjected to the hypothetical but extrapolated Greek rate of 32.16% on a £120,000 loan outstanding and a term of 10 years will pay £3,430 per month.