Bank of England policymakers will spell out the risks to financial stability from the deepening crisis in Greece, as analysts warn that a default could send shockwaves through the world's financial system.
Fears are growing that Athens could be forced to renege on its debts as the government faces a confidence vote over its austerity measures tomorrow. The Bank's new financial policy committee (FPC) will make its first public pronouncements on threats to the banking system on Friday, and is expected to put the possibility of a sovereign debt crisis high on its list. Michael Cohrs, the former Deutsche Bank boss who sits on the FPC, has already made clear that the biggest threat to stability is "sovereign risk".
He told MPs what "keeps me awake at night" is the interconnectedness of the system, which could create ripple effects through financial markets. He said financial regulators should check banks' exposures to the debts of vulnerable countries.
"Central bankers are paid to worry about these things," said Peter Dixon, UK economist at Deutsche Bank. "I don't think Greece itself is a first-order concern: it's the second-round effects which are more of a worry."
Steven Major, global head of fixed income research at HSBC, warned that events in Greece could have far-reaching consequences if they are not controlled. "It matters to the UK economy," he said. This is because a default by Greece or a renegotiation of a bailout could be taken as a signal by the Irish and Portuguese governments to alter their own bailout terms: "This is why it starts to matter. The UK has very little exposure to Greece, tiny exposure to its bonds and the inter-bank market. But the UK has much larger exposure to Ireland and Spain." He added that some speculators were hoping to profit from a default.
The Treasury select committee will this week be scrutinising the accountability of the Bank of England as it takes on new powers. The FPC is a central plank of George Osborne's new approach to regulating the financial markets, but does not yet have any formal powers to control risk in the financial system.
Danny Gabay of City consultancy Fathom said the major concern for central bankers if the chaos in the eurozone deepens is banks' indirect exposure to it through complex financial products such as credit default swaps.
"We have absolutely no idea where this is going to end until somebody pulls the plug," he said. "I don't know what the FPC can possibly do about this: there are no levers we can pull except 'sell, sell, sell', but who's going to buy?"
Eurozone finance ministers will meet in the coming week to try to finalise details of the latest rescue plan for Greece, after Germany's chancellor, Angela Merkel, and French president Nicolas Sarkozy announced that they had agreed the principles on which a new bailout would be drawn up