Europe may already have passed its biggest stress test.
The euro has rallied 8 percent from a four-year low last month. Greece, Spain and Portugal have sold 50 billion euros ($64 billion) of debt since May 10, when the need to save the single currency forced finance ministers to create a nearly $1 trillion rescue fund and European Central Bank President Jean-Claude Trichet to begin buying bonds.
“The market seems to be much more convinced following the bailout that the euro zone is working and the peripheral countries will be able to finance their debt,” said Christoph Kind, head of asset allocation at Frankfurt-Trust, which manages $17 billion. “This goes hand-in-hand with the appreciation of the euro against the dollar.”
The euro and European stocks rallied today after data showed growth in the euro area’s services and manufacturing industries accelerated as the debt crisis eased. The next stage in the EU’s effort to show the euro can withstand the fallout from the Greek-led turmoil comes tomorrow when officials publish results of bank stress tests. Regulators are relying on the exams to reassure investors about the health of financial institutions from Germany’s WestLB AG to Spanish savings banks.
“Sovereign and bank risks had become interwoven in markets’ eyes, and the stress tests will go some way toward alleviating fears that weakness in banks is going to undermine sovereigns,” said David Page, an economist at Investec Securities in London.
The cost of insuring against losses on bonds issued by Europe’s banks and insurers fell to the lowest in a week today on expectation of successful stress tests.
The tests are a “crucial reality check,” said Marco Annunziata, chief economist at UniCredit Group in London. If they prompt a negative market reaction, the ECB may face greater demand for liquidity from banks and have to extend the timeframe it lends unlimited amounts of cash to six or even 12 months, potentially delaying interest rate increases, he said.
The extra cost investors demand to buy Spanish and Portuguese bonds instead of comparable German securities declined after debt sales this week and those spreads have narrowed 24 percent and 19 percent respectively from euro-era highs in May. The cost of insuring against sovereign default has also slid and the Frankfurt-based ECB last week bought the lowest amount of bonds since its asset-purchase program began.
“The recent evolutions on the markets show we are in the process of winning back the confidence that we’ve lost, but the path will be long,” German Finance Minister Wolfgang Schaeuble said yesterday in Paris. “To advance on this path and to avoid a repeat of this sort of crisis, we cannot sit on our laurels.”
Demand for funding from the high-deficit nations will also ease. Spain is poised to pay off 24.7 billion euros in bonds and bills in July, the stiffest monthly redemptions remaining this year, and doesn’t face another bond maturity until July 2011. Portugal doesn’t have bonds maturing until April and Ireland has said it is fully funded until the second quarter of 2011.
“If we continue to see calmness in Europe between now and the end of summer, where unrest generally is the most pronounced, I think we will have a significant rally in the sovereign credits and in the European markets,” Laurence D. Fink, chief executive officer of BlackRock Inc., the world’s largest asset manager, said in an interview yesterday with Bloomberg Television’s Erik Schatzker.
A German-led economic rebound is also easing investor concern that the euro-area was headed for disaster. Economists at BNP Paribas SA yesterday revised up their growth estimates to show Europe’s largest economy expanding 1.5 percent in the second quarter from the previous three months. Goldman Sachs Group Inc. last week reversed an earlier forecast and predicted the euro will strengthen further against the dollar by January.
“We’re convinced the recovery for now is in play,” Page of Investec said.
Investors and policy makers are far from declaring mission accomplished, even with Trichet warning investors on July 8 against being “excessively pessimistic” about Europe. Budget cuts intended to tame deficits and calm markets may stall growth and are stoking public anger. Rising unemployment and austerity threaten to topple minority governments in Spain and Portugal.
“We are not the Titanic, but let’s not fool ourselves into thinking we are safe just because we have first-class tickets,” Italian Finance Minister Giulio Tremonti said July 20 at the University of Fribourg, Switzerland.
Pushback against austerity in Hungary highlights the risks for euro-region countries. Talks between Hungary’s two-month-old government of Viktor Orban, the EU and International Monetary Fund broke down this week, delaying payments from a 20-billion euro aid package. Orban sought to widen the country’s deficit targets after five years of belt tightening that led the economy to contract 6.3 percent last year. The standoff sent the forint to a 14-month low on July 19.
Workers in Spain, Portugal and Greece have taken to the streets to protest against the budget cuts that include higher taxes and lower wages for civil servants, typically the core supporters of the socialist parties that rule all three countries.
Greece, which triggered the crisis with the revelation that its deficit was more than four times the EU limit, is trying to trim the shortfall to 8.1 percent of gross domestic product this year, from 13.6 percent last year. Spain’s shortfall reached 11.2 percent last year with Portugal’s at 9.4 percent. None will return to the EU’s 3 percent limit before the start of 2013.
‘Not Out of the Woods’
Even if Greece achieves its deficit-cutting goals, the country’s debt is forecast by the government to peak at almost 150 percent of GDP in 2013, a level that may require a restructuring, says James Nixon, co-chief European economist at Societe Generale SA in London.
“We’re not out of the woods by any means,” said Nixon, a former ECB economist. “We’re dealing with a long-running, multi-year problem. You can have a good year, but you have to come back and do exactly the same next year and the year after.”