By Allan Biggar, Chairman of All About Brands PLC

Last week politicians in Washington concluded an agreement to raise the US debt ceiling to $14.3trn (£8.8trn) to prevent the world’s largest economy from defaulting on its debt repayments. This weekend the Eurozone, the world’s second largest economy, faced a similar situation; with fears that the crisis that had seen the bailout of smaller peripheral states such as Ireland, Portugal and Greece, risked spreading to the larger economies of Italy and Spain.

The fear of the slowdown of two of the world’s largest economies saw a dramatic sell off of shares across the world, as investors sought to limit the damage, wiping £3trn off stock markets worldwide.

What prompted concern in Europe were suggestions that current yields for both Italy and Spain are not substantial enough to fund their current rate of borrowing, suggesting that both nations may soon request a bail out from the European Central Bank or risk defaulting.

I don’t believe we are at the stage where Italy and Spain will default on their loan repayments, but there is the potential that this will push both countries and other Eurozone economies back into recession. Germany, the richest country in the Eurozone, has the lowest levels of debt; is growing ever more reluctant to continue to write cheques for member countries that lack the fiscal discipline and political will to implement tough austerity measures. Added to this is the weakness of the Berlusconi Government that risks collapsing, if the ‘fast paced’ austerity measures that will soon be voted on, fail to go in its favour.

European leaders such as Germany’s Angela Merkel and President Sarkozy of France have interrupted their holidays to discuss the crisis. David Cameron, himself on holiday, has telephoned the Governor of the Bank of England and Chancellor Merkel. Ollie Rehn, EU Commission for Economic and Monetary Affairs as well as Jose Barroso, the President of the European Commission, both have called for an increase in the European Financial Stability Facility EFSF at the same time appealing for calm. This mixture of a need for calm and lack of urgency from the Eurozone leaders and influencers is doing nothing to allay investors’ fears.

The UK although not in the Euro is still at risk, with the threat of contagion to its banking system. The knock on effects could be huge, as when investors lose confidence in a nation’s ability to repay its debt; this in turn has implications on those nation’s banks. Given the interconnected nature of banking, the exposure of the UK banks is high.

Investor confidence in the UK is relatively high given the circumstances, but that is due to UK banks’ lending more and UK companies exporting more. But, if UK banks cannot access finance, then they cannot lend to business, if business cannot access finance, then the fragile UK economy could slow down further. This also slows job creation and leading to even slower growth. This, together with the lack of public sector spending, further dampens economic activity; that could lead to a fall in investor confidence in the UK.

The potential of a fall in the value of the Euro and Dollar against the pound would see the cost of UK exports rise at a time when costs of living in Eurozone and US are rising, and job creation has stagnated. This fall in revenue for the UK economy could leave the Government no choice but to increase corporation tax, further damaging the recovery.

The Bank of England will publish its growth forecasts on the 10 August, and it is predicted they will be lower than the 1.75% forecast, with the CBI suggesting growth figures could be around 1.3%. This is due to the UK’s largest trade partners the US and EU engulfed by trouble.

These low UK growth forecasts are only further confirmed by news from America that the short lived boost in confidence over 117,000 new jobs being created in the last quarter, has been offset by fears that austerity measures agreed would slow down growth. On Friday, Standards & Poor’s, the credit rating agency downgraded America’s premium AAA+ credit rating to AA+, citing that political initiative on debt reduction did not go far enough, suggesting that tax rises were needed along with adjustments to Medicare. Something both the Republicans and Democrats resisted.

The S&P report was direct at laying the source of investor unease at the nation’s politicians saying; "the political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed."

With two the UKs biggest trading blocs’ grinding to a halt the need for a political solution is critical. The markets have demonstrated that investors have lost confidence in the ability of our politicians to stay ahead of the markets. The political inability to compromise and protracted dealings are damaging, whether it was the negotiations over the US debt ceiling or the inadequate fudging to Eurozone debt that we have seen in Greece and now witnessing.

Investors have seen that both EU and American politicians fudging the problem; throwing good money after bad is not the solution. The announcement that the ECB would buy Italian Government bonds was slow in coming, only highlighting the indecision in that organisation and suggestions that Germany is no longer willing to continue to bankroll such economic ineptitude of other members. If this is the case we could see a breakup of the Eurozone, with those countries that haven’t played by the rules expelled, and made to tough it out on their own. In the States the only comment from the Obama administration is over the debt ceiling and comments that it will ‘push back’ on the S&P rating.

The UK Government has announced it is monitoring the threat of contagion from US and EU banks, in an attempt to maintain investor confidence, allowing banks to continue lending to businesses. But now is the time for a strong Europe, not a divided one.

In terms of a silver bullet there is none. But what is needed is a clear consensus and plan across the whole of the Eurozone and US is needed. The calling of a G7 meeting to discuss the crisis is a positive, but politicians need to get back to their desks and postpone their holidays otherwise investors will continue to bulk.

About The Author

Allan Biggar is the Chairman of All About Brands PLC and formerly Global Chairman of Burson Marsteller Corporate & Financial.