Mounting anxiety in Brussels over Irish economic situation

PUBLIC SUPPORT in Brussels for Ireland’s efforts to fix the banks and the public finances comes amid mounting anxiety about the cumulative impact of the fiscal burden on the Government.

With bond yields rising to record levels as investors and the public await clarity on the final cost of rescuing Anglo Irish Bank, questions in Fianna Fáil over the position of the Taoiseach only add to the sense of urgency.

“Political stability is an asset in such a situation, where you have to take important and difficult measures,” was how one well-placed EU official responded to the turmoil in Dublin.

As is by now clear, the sense of vulnerability turns on the weakness of the banks in a scenario in which Ireland is already running the highest budget deficit in the euro area.

Although Minister for Finance Brian Lenihan won plaudits for decisive action to bridge the gap between expenditure and tax revenues, the benefit from these painful measures has been eroded by bank bailouts and consequent pressure on Irish borrowing costs.

This means there is less to be gained from future cuts and tax measures. Based on an updated 2010 deficit forecast due at the end of October, it may yet be possible to extend the 2014 deadline to achieve the 3 per cent deficit. If bond yields continue rising, however, the real benefit could prove minimal.

“The figures involved are very big – the deficit figures – and Ireland has already done lots in terms of measures of budget consolidation, which also have a social impact,” the EU official said. “The weak point here is the banking sector, the bank rescue – which is a pity, because without that Ireland has done its homework quite well.”

Further concern surrounds AIB, and the impact on Ireland’s bond yields is clear. The market demands an ever-increasing premium to hold Irish debt, bringing with it the attention of the world’s media and heightened scrutiny by professional analysts and short-term investors.

From Brussels, the inexorable forces at play in this domestic drama are seen as something with implications for the euro area at large. In this context, a prime concern is to avoid a situation in which market unease over Ireland undermines confidence in Portugal and Spain, the other weaklings in the present malaise.

The experience of the Greek financial crash – when a halting, uncertain response from the European authorities intensified the country’s difficulties – is also fresh in the memory. The sense is that any future interventions would come sooner.

All this means the pressures on Ireland are receiving special attention from the European Commission and the European Central Bank, which is known to be in the market for Irish debt.

While that is a valuable safety buffer, it means today’s auction is something of an artificial exercise in terms of gauging the true level of investor support for Ireland.

For the moment, it appears the European authorities trust the Government to continue taking difficult decisions to balance the books. The difficulty, however, is that control over the situation is largely out of the Government’s hands: it rests with investors who determine the cost of Irish debt.

If Irish yields continue to rise, they would ultimately reach a level at which raising money from the private markets would be impossible.

The pressure is on to re-establish lost market confidence. That is especially difficult. But the alternative is a call on special help from the EU and the IMF, something which see key budget decisions taken away from Dublin. The stakes are that high.