European policy makers received another vote of no-confidence in their efforts to stem economic turmoil as the euro fell to its lowest in more than two years following final approval for a bailout of Spanish banks.
The decision by euro finance chiefs failed to offset trouble elsewhere. Spanish Prime Minister Mariano Rajoy forecast a second year of recession and Valencia became the first state to say it would seek a rescue from the central government. Italian Prime Minister Mario Monti blamed unrest in Spain for surging borrowing costs, and an ally of German Chancellor Angela Merkel endorsed the prospect of Greece exiting the euro.
“We’re looking at a situation when people are realising we’re at a point of debt restructuring and repudiation,” Marc Ostwald, a fixed-income strategist at Monument Securities Ltd. in London, said in an interview yesterday. “It’s cold-hearted reality. The great blag and bluff of the euro zone has always managed to kick the can down the road, but it is no longer a viable strategy. We’re getting to a crunch point.”
The market declines came exactly a year after European leaders pledged a second bailout for Greece and empowered their rescue fund to aid banks and extend credit lines to safeguard Spain and Italy. Those efforts have fallen short, and Greece is now fighting for more help after the biggest debt restructuring in history. Spain is meanwhile paying record costs to borrow.
The euro fell 1 per cent to $1.216 at 7:59 p.m. in Brussels yesterday. The Euro Stoxx 50 Index slid 2.8 per cent, led by Italian banks. The risk premium to lend to Spain instead of Germany rose to the highest on record. In Italy, that spread climbed to the most since January. Investors who pay to lend to Germany for two years drove those securities higher.
“It looks like a lack of willingness of traders to hold positions over weekends,” said Tom Russo, a partner at Lancaster, Pennsylvania-based Gardner Russo & Gardner, which oversees $5 billion including US-traded shares of Nestle SA and Heineken NV. “Because you just never know. You have two days’ worth of risk and you can’t trade. Why not just de-risk your portfolio for the weekend?”
Even with euro-area finance ministers signing off on providing aid of as much as 100 billion euros ($122 billion) to Spanish banks, the officials continue to squabble over whether the burden of the emergency loans will be assumed by the Spanish government or the banks.
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Next, attention turns to the concerns looming over Greece. The country owes a 3.1 billion-euro bond payment, mostly to the European Central Bank, in August and the so-called troika of international creditors is due to arrive in Athens next week to begin quantifying how far off bailout targets Greece is.
While European officials have said the bond redemption won’t be an issue for cash-strapped Greece, they have declined to specify how they’ll ensure the payment gets made.
“Over the summer, we’re not going to see much progress and markets remain nervous,” said John Stopford, head of fixed income at Investec Asset Management in London, which oversees $98 billion. “The crisis is happening. The euro is disintegrating from the inside with a lack of cross-border lending.”
Monti, speaking in Rome, said the surge in his country’s borrowing costs resulted from anti-austerity demonstrations in Spain that are adding to investor concerns about European debt.
The difference between the yield on 10-year Italian debt and similar maturity German bunds rose 22 basis points to 500 basis points yesterday. Italian spreads haven’t ended a trading day above that level since Jan. 11.
“It’s difficult to say to what extent the contagion comes or came from Greece, or from Portugal, or from Ireland, or from the situation of the Spanish banks, or of the one apparently emerging from the streets and the squares of Madrid,” Monti told reporters. “Obviously, without the problems in those countries, Italy’s interest rates would be lower.”
The ongoing crisis will force the ECB to cut its benchmark 0.75 per cent interest rate in October and also reduce the rate it pays on overnight bank deposits to below zero, Greg Fuzesi, an economist at JPMorgan Chase & Co., said in a report.
The aim would be to reduce funding costs for banks in the periphery reliant on ECB support, pulling down market borrowing costs and forcing investors to buy riskier-assets, he said.
In Spain, Rajoy is fending off international investors, domestic protesters and his own states as the slump in the fourth-biggest euro economy deepens. The Ibex stock index tumbled 5.8 per cent, the biggest daily drop since May 2010. Ten- year yields rose to 7.28 per cent, driving the gap with German bonds to a euro-era record of 610 basis points.
Gross domestic product will fall 0.5 per cent in 2013 instead of rising 0.2 per cent as the government predicted April 27, Budget Minister Cristobal Montoro said after the Cabinet met in Madrid. The government will spend 9.1 billion euros more paying interest than in 2012, he said.
Meantime, Valencia, Spain’s second-most indebted state, said it would tap an 18 billion-euro emergency fund Rajoy set up last week for bailing out regions.
“This is a region which we’ve known for some time, which has been widely known for some time, has been facing difficulties,” European Union spokesman Simon O’Connor said in a Bloomberg Television interview. “The financial assistance comes with very strict conditionality which in many ways mirrors the system that we’ve put in place for the euro zone.”