FEARS THAT the euro zone’s firewall will prove insufficient to shield Spain and other embattled countries against the effects of a possible disorderly Greek exit from the currency union hit European financial markets yesterday.
Spanish and Italian 10-year borrowing costs shot up to their highest levels this year, and European stock markets suffered their biggest one-day drop in three weeks.
German 10-year bond yields fell to a record low, widening the premium Madrid pays to borrow compared with Berlin to a new euro-era high.
“It’s looking alarming right now,” said Luke Spajic, a senior fund manager at Pimco, one of the world’s largest bond investors. “The market is effectively trying to price in a disorderly exit for Greece.”
The chance of Greece falling out of the euro zone – previously seen as a cataclysmic event that many European policymakers had refused to discuss – has attracted renewed speculation following an election that resulted in strong gains for parties opposed to budget cuts imposed as a condition for Greece’s bailout.
European leaders have created a €500 billion euro zone rescue system, the European Stability Mechanism (ESM), as a financial firewall. However, many analysts and investors have questioned whether it is big enough to rescue the larger economies at risk, such as Spain and Italy.
“The firewall is big enough in theory for Spain,” said Justin Knight, a strategist at UBS, but added that the ESM would be likely to face practical difficulties raising large loans.
Although Spain has announced deep budget cuts and new plans to strengthen its banks, concerns over economic contraction and souring property loans have grown. The cost of insuring against a Spanish default hit a record yesterday.
European Central Bank borrowing by Spanish banks jumped 16 per cent to a record €263.5 billion in April after lenders tapped emergency loans.
Four small Spanish savings banks are working on a merger supervised by the ministry of economy that could create the country’s fifth largest lender with assets of €270 billion, raising concerns among analysts after last week’s €4.5 billion state rescue of Bankia, itself the dysfunctional result of a seven-way merger of savings banks.
Luis de Guindos, the Spanish finance minister, insisted the market turbulence was due to political uncertainty in Greece and not a verdict on his government’s efforts to shore up the banking sector, arguing Madrid had “done what we had to do”.
“Spain has taken measures, implemented a very deep banking clean-up, to improve our fiscal situation,” Mr de Guindos said. “What we need now is the co-operation of the euro zone.”
However, Jean-Pierre Jouyet, head of France’s financial markets regulator and adviser to incoming president François Hollande, warned “there is a risk of contagion”. He said: “If Greece left the euro, which is a hypothesis that today we cannot avoid, we have to look at the chain of consequences” for banks.
European banks were hit hard by the contagion concerns, shedding almost 4 per cent of their stock market value.
“The threat of a Greek exit certainly raises the risk for a major sell-off in the euro/dollar as the fundamental outlook for the region turns increasingly bleak,” said David Song, currency analyst at DailyFX.
The euro fell as low as $1.2823, its lowest level since January 18th. It has lost 3 per cent so far this month after losing 0.8 per cent in April. – (Copyright The Financial Times Limited 2012/Reuters)
