The rumbling crisis over the integrity of the eurozone has entered a new and ominous phase, with economists and bond market investors questioning the ability of “peripheral” European economies to stay in the euro without yet another rescue package.
On Tuesday, measures of risk for the government bonds of countries such as Greece, Ireland, Portugal and Spain rose for the 11th day running.
In some cases, credit default swaps, akin to insurance, and interest rate spreads over Bunds, representing the higher perceived risk over benchmark German debt, have surged to record levels.
Market confidence – which returned in the late summer following the €110bn bail-out of Greece by the European Union and the International Monetary Fund and the subsequent launch of a €440bn European financial stability facility for the broader eurozone – has evaporated.
At issue is what some see as a slow and uncertain response from the EU and the European Central Bank to the latest tensions in the market.
The eurozone countries now coming under pressure“need a response at the level of Frankfurt and Brussels,” said Edward Hugh, a Barcelona-based economist.
“Each of the individual countries can only do so much. You need some co-ordination and leadership.”
The ECB has this week again bought eurozone – largely Irish – government bonds.
But its purchases are on a small scale.
The ECB’s scope for action in bond markets is also limited by opposition from Axel Weber, Germany’s Bundesbank president, who fears damaging consequences from using the ECB’s firepower for fiscal rather than monetary ends.
There are two main reasons for the collapse of confidence among investors.
First is the realization that an EU plan for a mechanism to resolve future sovereign debt crises, agreed at a summit last month, could severely penalize private sector bondholders.
In the event of a debt restructuring, they could be forced to accept so-called “haircuts”, or discounts on the value of their holdings.
Officials in Brussels believe the markets are behaving irrationally and say the new bail-out system will apply only to debt offerings after the current temporary rescue fund expires in 2013.
Irish, Portuguese and Greek debt currently being traded, they insist, will be treated just as it was before the EU summit decision.
The second cause of rising bond yields is that harsh economic austerity programmers have turned out to be less effective than hoped at cutting budget deficits but have fulfilled gloomy predictions that they would stifle any incipient economic recovery.
“The European peripheral countries are all suffering from the combined realization by the market that the promised reforms are slow in coming and unlikely to deliver substantially higher growth in the near term – and that fiscal retrenchment is painful and partially self-defeating in terms of growth,” said Luis Garicano, professor of economics and strategy at the London School of Economics.
In the first nine months of this year, Portugal’s deficit actually rose slightly, prompting a new and more drastic austerity plan approved in principle by parliament last week.
Ireland, after the collapse of its property market in 2008, was one of the first eurozone countries to address the hole created in its public finances.
But while bond markets reacted favorably at first, sentiment has since turned negative as the scale of its banking sector problems has been exposed.
In Spain even an official finding that unemployment had fallen slightly in the quarter to just below 20 per cent of the workforce was no comfort.
The extra employment was in the public sector, which was supposed to be reducing its numbers to curb the deficit.
Worse still, in the eyes of investors, are suggestions the government plans to delay pension reform until next year, when the reforms risk being abandoned in the run-up to municipal and regional elections in May.