Leaviss: Greek euro exit would trigger 'horrifying' run on banks

If Greece leaves the euro, banks across the Continent will suffer "horrifying" consequences, with a run on banks worse than anything seen before, said M&G's bond star Jim Leaviss.

Delivering a warning to politicians in Europe, Leaviss said Greece should be allowed to default rather than exit the euro in order to save the financial system from an even greater crisis.

"Greece can default but it must not leave the euro," Leaviss said. "If it does we will see runs on Europe's banks that dwarf what we have seen so far."

Leaviss, head of retail fixed interest and manager of the £305m M&G UK Inflation Linked Corporate Bond fund, said the steps taken so far in Europe are not enough to avert a breakup.

"The consequences of a eurozone breakup are horrifying, and the cost - even for Germany - should focus the minds of politicians. But 17 democratically elected leaders won't be able to make the necessary structural changes to the euro quickly enough," he said.

Instead Leaviss suggested the European Central Bank (ECB) should cut rates again, and keep buying peripheral debt, to stave off a banking meltdown.

"Europe should be able to solve its problems with the help of the ECB by cutting rates to 0.5%, expanding its Securities Market Programme's (SMP) buying of peripheral bonds, and by forcing the European banking sector to recapitalise," he said.

Looking into 2012 and beyond, Leaviss added central banks around the world are changing their raison d'être to focus on tackling unemployment rather than keeping inflation stable.

While inflation has so far been central banks' main concern, Leaviss said growing social problems and sluggish growth will be seen if central banks do not prioritise boosting growth and reducing unemployment. As a result, he expects interest rates to be kept below inflation rates for the foreseeable future.

In order to exploit this, Leaviss is backing inflation-linked bonds to provide a cheap insurance policy against the possibility of higher than expected inflation in 2012.

"In a world of money printing, with utility bill hikes and higher tuition fees still to come through, we think it is unlikely we will see deflation," Leaviss said.

"Additionally, the Bank of England will have to buy index-linked gilts as part of the QE programme as it is running out of nominal gilts to buy."

The manager said with gilt yields at record lows, growth below trend, interest rates on hold, and central banks buying huge tranches of government bonds, the upside looks limited for gilts.

Elsewhere, heading into the new year, Leaviss is favouring high yield debt.

He said: "Given high yield companies have extended the terms of their borrowing to avoid refinancing risk in the next couple of years, we foresee very low default rates in the near term.

"The newly developing senior secured high yield market, which is gradually replacing the bank-funded leveraged loan market, provides a new opportunity for lower risk junk bond investing. The 8%-12% yields on offer from investing in senior secured paper issued by certain packaging and cable companies look particularly attractive."