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EU Fund ‘Increasingly Likely’ to Be Tapped, Morgan Stanley Says

It is becoming “increasingly likely” that a European government will need to tap the rescue fund established to aid nations facing sovereign debt crises, according to Morgan Stanley.

Four months after European Union policy makers created the 440 billion-euro ($560 billion) European Financial Stability Facility, yields on 10-year Irish and Portuguese debt rose to records this week versus German bunds amid renewed investor concern over the finances of debt-strapped governments.

“With government bond yield spreads for some peripheral countries like Ireland or Portugal continuing to widen, it becomes increasingly likely that euro-area governments’ hopes that the mere existence of the EFSF will calm markets and ensure that it will never be used could be disappointed,” Joachim Fels, Morgan Stanley’s co-chief global economist wrote in a report released today.

The fund, based in Luxembourg and run by former European Commission official Klaus Regling, was established in May as the Greek debt crisis threatened to spill over to other euro states. That crisis is not over and “autumn looks set to bring new challenges to Europe,” London-based Fels said.

A request for help from the fund could speed the end of the continent’s turmoil by proving the terms of the aid are credible and by directing funds to banks to plug holes in their balance sheets, Fels said. By contrast it could risk exacerbating the crisis if the fund failed to demand tough enough policy changes or if the bond sales by the fund lured investors away from buying the debt of countries such as France or Germany, he said.

‘Two-Edged Sword’

“The use of the EFSF by one or several countries would be a two-edged sword,” said Fels.

A senior lawmaker from German Chancellor Angela Merkel’s party said yesterday that countries probably won’t need assistance from the fund. “I see -- and Mr. Regling stressed that as well in the past days -- that the stabilization fund is probably not going to be used,” Leo Dautzenberg, parliamentary Finance Committee spokesman for Merkel’s Christian Democratic Union, said in an interview.

There is also a “significant risk” that the debt crisis could migrate to core European economies such as France and Germany, Fels said. The European Central Bank may then be forced to widen its purchases of government debt, he said.

European central banks yesterday bought Greek, Irish and Portuguese bonds, according to a trader involved in the transactions. The Frankfurt-based ECB said Sept. 6 it bought 173 million euros of government debt last week.

“It would be difficult for the ECB to refuse extending its purchases to core euro area government bonds, should the sovereign crisis migrate to the core,” Fels wrote.

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