Europe Failed to Clear 'Skepticism' on Debt Crisis, IMF Says

Europe has yet to allay investor “skepticism” about the sustainability of the region’s debt, and any spread of the crisis would cloud the global economic outlook, the International Monetary Fund’s No. 3 official said.

“At least for now it looks like the spillover from the European sovereign crisis to areas outside of the region will be limited,” Naoyuki Shinohara, deputy managing director at the IMF, said in an interview in Tokyo yesterday. “However, if the European sovereign-debt problems were to become bigger, we need to keep in mind that that could bring about considerable downside risks.”

European officials have indicated they’re ready to expand their efforts to contain the crisis that erupted last year and has led to bailout packages for Greece and Ireland. German Chancellor Angela Merkel this week expressed willingness to take whatever steps are needed to stem the turmoil.

The extra yields investors demand to hold Greek and Irish bonds rather than German bunds “still remain very high, despite the rescue packages,” Shinohara said.

“That means skepticism over the sustainability of their debt in the market hasn’t been cleared away,” said Shinohara, 57, a former top currency official at Japan’s Ministry of Finance. “It’s important that countries reduce their budget deficit, but they also need to tackle structural issues including boosting growth and lowering unemployment.”

Brighter Outlook

European Central Bank council member Axel Weber, who heads Germany’s Bundesbank, said the euro area’s economic prospects have “brightened considerably” though inflation risks may rise. “The recovery should continue,” he said today in a speech in Vallender, Germany.

The euro headed for its biggest weekly gain in almost two years amid speculation inflation pressure may spur the ECB to raise borrowing costs. The currency was little changed at $1.3365 as of 10:28 a.m. in London after earlier climbing to $1.3457, the strongest level since Dec. 14. It was 3.5 percent higher in the week, the biggest advance since May 2009.

“The steps that European Union officials can announce in terms of increasing the fund’s size that they have to help the peripheral countries can still take a few weeks to happen,” Mansoor Mohi-uddin, Singapore-based head of global currency strategy at UBS AG, said in a Bloomberg Television interview. “I’d rather still be a seller of the euro on the rallies.”

‘Stand by’ Euro

The extra yield investors demand to hold 10-year Spanish government bonds rather than German bunds touched a record 298 basis points on Nov. 30 compared with an average of 15 basis points over the first decade of the monetary union. The spread was 233 basis points after Spain yesterday sold 3 billion euros ($4 billion) of bonds in its first debt auction of the year.

Merkel said on Jan. 12 that “we’re saying what we’ve always said since the Greek crisis: We will stand by the euro.” She was responding to EU Economic and Monetary Affairs Commissioner Olli Rehn’s call for a “comprehensive” plan to contain the sovereign-debt crisis.

His proposals included expanding the “size and scope” of the EU’s 440 billion-euro rescue fund, the European Financial Stability Facility.

Shinohara, who directed Japanese currency policy as the vice finance minister of international affairs from July 2007 to July 2009, called Japan’s plan to buy bonds to fund Ireland’s bailout a “very welcome development.” The purchases “aren’t a bad investment” for Japan because they would involve AAA-rated bonds and offer higher yields relative to German bunds, he said.

Buying Bailout Bonds

Finance Minister Yoshihiko Noda said on Jan. 11 that Japan will use existing euro assets in its foreign-exchange reserves to buy more than 20 percent of the bonds to be issued later this month by the EFSF.

Japan is considering more purchases of European bailout bonds in coming months to help boost confidence in the euro area, according to the two officials, who spoke on condition of anonymity because the government’s plans aren’t public.

In real effective exchange-rate terms, the value of the yen is “broadly in line with medium-term fundamentals and close to its long-run historical average,” Shinohara said.

The weighted average of the yen’s exchange rate against other currencies was 104.25 in November after rising to 105.17 in October, the highest since February 2009, according to the Bank of Japan.

Shinohara also said China should allow the yuan, also known as the renminbi, to appreciate faster to rebalance its economy.

“We continue to view the renminbi as substantially below the level consistent with medium-term fundamentals,” he said. “However, the exchange rate should not be viewed in isolation and a broad range of policies will be needed if China is to successfully rebalance its economy,” he said, adding that too rapid an appreciation of the currency is undesirable.

To contact the reporters on this story: Keiko Ujikane in Tokyo at kujikane@bloomberg.net; Tatsuo Ito in Tokyo at Tito2@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net

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