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Wednesday, September 26, 2012

Eurozone crisis returns to rattle markets after period of calm

Economic figures from France, Italy and Spain mixed with civil unrest and political dithering cause stock exchange turbulence

Market jitters over Europe's debt crisis returned after weeks of relative calm on Wednesday amid a welter of grim statistics from some of the biggest European economies, mixed signals from bickering eurozone political leaders, and mass protests against austerity in southern Europe.

As unrest gripped Greece, Spain, and Portugal, Madrid's borrowing costs surged through the 6% threshold after the leading eurozone creditors made it plain that a planned €100bn (£80bn) bailout for Spanish banks would saddle the country with higher debt levels.

The lack of political will to fix the crisis was reinforced by the European commission flatly contradicting the governments of Germany, the Netherlands and Finland after they walked away from pledges delivered at an EU summit in June.

The grimmer mood enveloping the eurozone was also underlined by figures from France putting the jobless rate at more than 3 million for the first time in 13 years and by falling retail sales reported from recession-hit Italy. Stock markets fell across Europe with the FTSE 100 down 1.5%, while the German Dax and French Cac 40 were down 2% and 2.8%. The surge in French unemployment will complicate President François Hollande's hopes of beginning to tackle France's economic malaise. The increased expenditure on benefits and the fall in tax receipts will also make it harder for France to meet the EU-prescribed budget deficit target of 3% by next year.

Hollande came to power in May on a campaign of resisting German-led austerity. He now needs to plunge France into austerity — though he does not use that term — to make savings of €30bn through spending cuts and tax rises. Details will become clearer on Friday when his government's first budget, for next year, goes to cabinet.

Mired in a deepening recession, with the economy projected to shrink by at least 2.4% this year, Italy also posted more bad news, with retail sales figures for July showing a 3.2% fall on a year ago.

But as Madrid's cost of borrowing shot up, Spain's predicament — coupled with the widening eurozone splits over how to respond — was the biggest factor unnerving the markets. While the prime minister, Mariano Rajoy, appears condemned eventually to having to request a humiliating bailout which, according to German finance ministry estimates, could amount to €300bn, he continues to play for time.

The eurozone is divided over how to respond. Hollande and the Italian prime minister, Mario Monti, are pressing Rajoy to request a bailout. Berlin is encouraging him to play for time. Chancellor Angela Merkel is moving into an election year and is reluctant to return to parliament in Berlin to argue for another unpopular eurozone rescue programme.

The split between Berlin and Paris over Spain reflects much broader and fundamental divisions over policies dealing with the sovereign debt crisis. Two big policy shifts in recent months brought a respite in the crisis, giving leaders time to come up with more substantive action.

In June, an EU summit declared that policy had to be aimed at breaking the vicious circle linking vulnerable banks and weak sovereigns in a downward spiral of bigger debt. To that end, they decided to use the eurozone's bailout funds to recapitalise weak banks directly without adding the loans to a state's debt.

The second big move was from the European Central Bank which earlier this month announced a new policy of unlimited intervention in the markets to buy up shaky government bonds. The June consensus on lending directly to weak banks was always fragile, but collapsed on Tuesday when the eurozone's key triple-A rated creditors, Germany, the Netherlands, and Finland, issued a surprise statement declaring the bailout funds could recapitalise banks directly only as a last resort, that the policy was a longer-term option, and could not be applied to pre-existing or "legacy" bailouts, namely Spain and Ireland who had their hopes pinned on the June breakthrough. Direct bank recapitalisation has been effectively frozen before it even began.

On Wednesday, the European commission stemmed the shift from the three countries, insisting policy agreed in June had to be implemented promptly. "Our position regarding breaking the vicious circle between the banks and the sovereign is very clear … This should be done quickly" said EC spokesman Olivier Bailly.

In agreeing to the direct bank loans in June, Berlin demanded that first there needed to a new regime based at the ECB for supervising eurozone banks. The commission drafted the complex legislation in less than three months, unveiling it a fortnight ago. Berlin is now dragging its feet, delaying the new regime while insisting it should not police the vast majority of German banks.

In sharp contrast, France's Europe minister, Bernard Cazeneuve, said this week in Brussels that the new bank supervisory regime had to be created as a matter of urgency.


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