Markets spooked by Italian, Greek woes

2011-11-08 14:02

Rome/Athens - Financial markets held their breath on Tuesday as Italian Prime Minister Silvio Berlusconi’s reform-shy government teetered on the brink and debt-crippled Greece’s leaders struggled to put together a national unity government.

Rome has displaced Athens as the epicentre of the eurozone’s sovereign debt crisis, with government bond yields nearing unsustainable levels that could force the bloc’s third-largest economy to seek a bailout Europe cannot afford.

Italian 10-year borrowing costs touched a new record of 6.71% on Tuesday, raising the risk that Rome’s massive debt - the second-highest in Europe at 120% of gross domestic product - could spiral out of control.

“Now we are really reaching very dangerous levels... We are above yield levels in the 10-year where Portugal and Greece and Ireland issued their last bonds,” said Alessandro Giansanti, a rate strategist at ING.

Under massive pressure to resign, Berlusconi faces a crucial vote on public finances in parliament that could sink his centre-right coalition if enough party rebels desert him.

Five lawmakers in his PDL party said they would abstain, putting Berlusconi’s majority in danger. The main opposition parties said they would also abstain, allowing last year’s budget to be approved while highlighting the government’s weakness.

The 75-year-old billionaire premier, battered by a series of trials and sex scandals, may face a tough confidence vote this week even if he survives on Tuesday.

Eurozone finance ministers, meeting in Brussels, agreed on Monday on a roadmap for boosting the 17-nation currency bloc’s €440bn ($600bn) rescue fund to shield larger economies like Italy and Spain from a possible Greek default.

But with bond investors increasingly on strike, there are doubts about the efficacy of those complex leveraging plans.

Countries outside the euro area kept up a chorus of pressure for more decisive action to stop the crisis spreading.
“The eurozone needs to show the world it can stand behind its currency; it cannot just wait on developments in Athens and in Rome,” British Finance Minister George Osborne said.

“We must also make progress here in Brussels. If we don’t, that will continue to have very damaging effects on the entire European economy.”

Swedish Finance Minister Anders Borg said: “Europe is running dry on credibility and a solution to a high debt crisis must be lower debt. The responsibility for that falls with the country with high debt and that is obviously Greece and Italy.”

Distress signals

Distress signals from the bond market and the European Central Bank (ECB) showed the crisis is gathering pace alarmingly.

Shifts in the Italian yield curve and a widening gap between the prices bondholders demand for Italian debt and what potential buyers are prepared to pay are flashing warning signs similar to those seen in Portugal, Greece and Ireland before high borrowing costs froze them out of debt markets.

In a sign that they are increasingly cut out of money markets, the ECB reported that Italian banks needed €111.3bn in central bank funding in October, up from €104.7bn in September and a mere €41.3 bn in June.

Even the European Financial Stability Facility (EFSF), the eurozone’s bailout fund, had difficulty finding buyers for its top notch AAA-rated paper on Monday, drawing barely enough bids for €3bn of 10-year bonds issued to support Ireland.

EFSF head Klaus Regling cited a “very difficult” market climate and uncertainty about the fund’s future profile as factors in the weak demand.

In Athens, wrangling continued to try to form an interim administration to save Greece from bankruptcy by enacting a second international bailout plan before early elections, after Socialist Prime Minister George Papandreou agreed to step down.

Early signs that a deal was within reach on a “100-day” government to push the €130bn bailout, including a “voluntary” 50% writedown on Greece’s debt to private sector bondholders, through parliament by February appeared to be fading over the choice of prime minister.

Former ECB vice-president Lucas Papademos was in talks with ruling Socialist and conservative opposition leaders on heading the government, but one sticking point was whether members of the main opposition New Democracy party would join the cabinet.

In Brussels, the 27 European Union finance ministers were debating how to strengthen Europe’s shaky banks to cope with the sovereign debt shock without halting lending to the “real economy”.

Options on the table included offering state guarantees to borrower banks or injecting cash into the European Investment Bank, the EU’s soft loan project finance arm, so that it can lend them more.

A bank recapitalisation agreed at last month’s EU summit will cost about €100bn, the European Banking Authority said, and some countries wanted a more flexible definition of capital to reduce the overall cost.