Irish Rescue Accord Turns Investors' Focus to Spain, Portugal: Euro Credit
Ireland’s plan to seek a European rescue risks escalating, rather than alleviating, the sovereign debt crisis as investors turn their focus to the high budget- deficit nations of southern Europe, led by Portugal.
Ireland’s Nov. 21 decision to request emergency aid from the European Union and the International Monetary Fund fueled a surge in Spain and Portugal’s borrowing costs. The extra yield demanded to hold Portuguese 10-year debt rather than German bunds rose 27 basis points today to 434. The Spanish spread with Germany climbed 27 basis points to 236, a euro-era record, after the Treasury sold 3.26 billion euros ($4.4 billion) of bills. That was less than the maximum target.
Even as EU leaders said Ireland’s bailout will stem contagion in the euro region, investors are turning their attention to Portugal, which hasn’t cut government spending and has barely grown for a decade. A rescue of Portugal may increase pressure on its high budget-deficit neighbor Spain, whose gross domestic product is almost twice the size of Portugal, Greece and Ireland combined.
After Portugal “the next question would be Spain and then Italy and then France and then the EU,” said Antonio Garcia Pascual, chief southern European economist at Barclays Capital in London. “Spain is a bit too big to be bailed out, the size of a rescue required would use up all the funds available and then you have Italy with contagion as well,” prompting “a situation where the euro itself is put into question,” he said.
Ireland’s 10-year bond plunged today, with the yield rising 34 basis points to 8.64 percent. Portugal’s 10-year yield increased 24 basis points to 7.05 percent, while Spain’s gained 17 basis points to 4.92 percent.
The Irish rescue, like the Greek plan, would likely involve three-years of emergency financing, allowing the government to avoid the soaring borrowing costs being demanded in the markets. Spain faces more than 150 billion euros in maturing bonds in that period plus the costs of having to finance the region’s third-biggest budget deficit. Bailing out Spain would strain the 750 billion-euro financial lifeline set up by the EU and the IMF to protect the region after Greece’s near default.
“The Portuguese and the Spanish are trying to distance themselves” from Ireland, Jim O’Neill, chairman of Goldman Sachs Asset Management, said in an interview with Deirdre Bolton and Erik Schatzker on Bloomberg Television’s “Inside Track” today. “I’m not sure how we can put this one to bed. We’ve got some fundamental problems” with the euro area, he said.
DeAnne Julius, a former Bank of England policy maker who is now chairman of Chatham House, a U.K.-based research group, said investors are likely to switch their focus to the Mediterranean.
“I think that we’re likely to see that liquidity assault shift from Ireland to Portugal,” she said in an interview with Bloomberg Television today. “The real issue will be if it then moves on to Spain, which is of course is a more economically weighty country within the euro zone.”
Ireland became the first euro country to move to tap that rescue fund as the cost of salvaging banks hit by the collapse of a property boom threatened a rerun of the Greek debt crisis that destabilized the currency in April and May. The government hasn’t given figures on the size of the package, which Goldman Sachs Group Inc. estimates may amount to 95 billion euros.
Amid increasing concerns over implementation of the rescue, Prime Minister Brian Cowen said last night he would seek national elections early next year after his government passes its 2011 budget. The announcement came hours after the Green Party said it would pull out of the ruling coalition following the budget vote. The group said Cowen has misled voters in negotiating the bailout.
There’s a “substantial risk” that Portugal will have to follow Ireland into a European rescue, said Ralph Solveen, an economist at Commerzbank AG in Frankfurt. “They have problems to reach their deficit goal this year, they have big structural problems and therefore they will still be in the focus of the market.”
Portugal’s debt amounts to 76 percent of gross domestic product, compared with 53 percent in Spain, 66 percent in Ireland and 116 percent in Italy last year. Spending by the Portuguese government, which lacks a parliamentary majority, continued to grow in the first 10 months of 2010, Finance Minister Fernando Teixeira dos Santos said on Nov. 17.
The country has pledged to cut its deficit to 7.3 percent of GDP this year and 4.6 percent in 2011, compared with last year’s 9.3 percent, the fourth-largest shortfall in the euro region.
It is “inevitable” that Portugal will seek help, said Stuart Thomson, who helps manage $110 billion at Ignis Asset Management in Glasgow. Royal Bank of Canada Europe Ltd. said it expects Portugal to request aid in the first quarter of 2011 at “the latest.”
That inevitability in the minds of investors was reflected in the rising cost of insuring against a Portuguese default. Credit-default swaps tied to Portuguese debt jumped 28.5 basis points today to 486, according to data provider CMA in London and Spain rose 17.5 basis points to 299.25.
The run up to Ireland’s decision to seek aid did trigger a slide in its borrowing costs, indicating investors may get burned betting against bonds of so-called peripheral markets. said Gilles Moec, an economist at Deutsche Bank AG in London. The Irish spread over Germany narrowed about 100 basis points since the Nov. 11 euro-era record of 652.4.
“For the market it’s no longer a one-way bet,” he said. “If the market pushes another country more and more, and the next in line is of course Portugal, you never know at what point the rescue is going to be triggered, and once the rescue is triggered, long-term interest rates fall.”
Angel Gurria, the head of the Organization for Economic Cooperation and Development said yesterday bank failures in Ireland had “nothing to do with Portugal” and that contagion “should not happen.” As the European Commission said the Irish plan was meant to stop contagion, Economic and Monetary Affairs Commissioner Olli Rehn said Portugal’s economic problems are “very different” to those of Ireland and its government has taken “bold decisions” on the deficit.
Still, fallout from Greece’s near default didn’t end with that country’s bailout in May. The yield premium on Irish debt has more than doubled since then. Portugal’s spread has doubled.
“The comments from Rehn are pure comedy,” Ignis’s Thomson said. “He said exactly the same about Ireland a few weeks ago.”
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