EU Puts Burden on Bailout States to Stop Crisis: Euro Credit

German Chancellor Angela Merkel
German Chancellor Angela Merkel said after the Brussels talks that the latest salvo of measures sends an important message on the political pledge of the euro members to fight for the euros stability. Photographer: Jock Fistick/Bloomberg

European leaders are betting their retooled bailout plan can defuse the region’s debt crisis as they reject costlier remedies and put the onus for stopping the turmoil on cash-strapped governments.

In a pact struck in the early hours of the weekend and two weeks sooner than investors expected, officials broadened the size and scope of their 440 billion-euro ($614 billion) bailout fund and eased the terms of Greek rescue loans. They resisted calls to buy bonds in the open market or finance buybacks.

The euro gained and bonds of the most-indebted nations rallied, reversing a slump last week that sent yields on Greek and Portuguese debt to euro-area records. Greece is fighting to show it can remain solvent and Portugal may be the next to seek aid. Renewed declines may force policy makers back to the drawing board when they reconvene March 24-25.

“Policy makers understand that market sentiment is crucial, and at least in the near-term, these measures are likely to improve sentiment,” said John Stopford, head of fixed income at Investec Asset Management Ltd. in London, which manages $80 billion. “I need to see how they are implemented. I’m happy to stay away from peripheral bonds for now.”

Yields on 10-year Greek debt today fell 58 basis points to 12.24 percent as of 10:55 a.m. in London, while those on similar-maturity Spanish debt dropped 17 basis points to 5.26 percent and Italian 10-year bond yields were 9 basis points lower at 4.77 percent. The yield on Germany’s two-year note gained five basis points to 1.70 percent while that of the German bund was seven basis points higher at 3.27 percent.

The weekend agreement, which finance ministers will detail in meetings later today and tomorrow, may boost demand for the short-term debt of strained economies, said Steven Major, global head of fixed-income research at HSBC Holdings Plc in London.

‘Genuine Surprise’

“European leaders have delivered a genuine surprise just when the market was starting to fear the worst,” he said.

Thirteen months since they began fighting the crisis, euro leaders find themselves still needing to assure investors they have the tools and the will to protect the single currency.

“We’ve come further than most people expected,” German Finance Minister Wolfgang Schaeuble told reporters in Brussels today. Luxembourg Prime Minister Jean-Claude Juncker said financial markets “should have understood that the willingness of the European Union and mainly of the euro areas members states is a total one to make sure that a comprehensive answer will be delivered.”

The European Financial Stability Facility will now be able to spend its full 440 billion-euro capacity and buy bonds directly from governments after collateral rules required to secure an AAA credit rating previously limited its lending power to about 250 billion euros and Germany opposed asset purchases.

Bond Purchases

The primary-market purchases will still just be used as an exception and only in return for austerity commitments.

They would hand a backstop to indebted nations should a Greek restructuring spook markets and threaten to derail other government bond auctions, said Andrew Bosomworth, a fund manager at Pacific Investment Management Co. in Munich.

Dimitris Drakopoulos, an economist at Nomura International Plc in London, said such purchases may also ease the way for Greece to begin selling bonds again in the first quarter of 2012. The yield on the country’s 10-year debt touched 12.5 percent on March 11. Germany’s comparable bund was 3.2 percent.

Almost doubling the amount available in the fund frees up enough money to support Ireland, Portugal and Spain for about two and half years, although it would not be large enough to bail out Italy and Belgium, said Bosomworth, who used to work at the European Central Bank.


“I’m positively surprised, for a change,” he said. “The agreement contains important elements of a firewall” that could stop the crisis worsening.

Where the leaders held back was in rejecting the lobbying of ECB President Jean-Claude Trichet to allow the facility to buy bonds in the open market. The ECB has pushed such a decision to enable it to withdraw from markets after buying about 77 billion euros of bonds since last May.

The commitment wasn’t matched with detail as German Chancellor Angela Merkel indicated only states will have to increase their guarantees. She herself may face political obstacles at home with an electorate opposed to putting more German money at stake, said Holger Schmieding, chief economist at Joh Berenberg Gossler & Co. in London.

German Risk

“The risk that the parties backing Merkel may possibly lose a string of regional elections on March 27 does not make the situation easier,” said Schmieding. “Still, German politicians have a record of living up to their pro-European credentials whenever it really counts.”

In a reward for its austerity program and 50-billion-euro privatization program, leaders made a provisional agreement to lower Greece’s interest rates of about 5 percent for aid by 100 basis points. They also extended the repayment period of the loans to 7 1/2 years from three years. Greek Prime Minister George Papandreou estimates the moves would save about 6 billion euros over the life of the loans.

Ireland failed to secure similar relief on its 85 billion-euro bailout as recently elected Prime Minister Enda Kenny refused to yield to calls to raise its 12.5 percent company tax rate, calling the proposal of Germany and France “harmonization of taxes through the back door.” Negotiations will continue with the aim of a deal at the March-end talks.

Among the other deals done at the summit was a plan to tighten economic cooperation -- committing nations to enact budget rules into law, a core German demand. A basic accord was also reached on a permanent 500 billion euro safety net from 2013, the European Stability Mechanism, with a mix of guarantees and capital.

Portugal’s Fate

The immediate focus for investors is now whether to keep avoiding the debt of Portugal, pushing it closer to pressing the aid button. With the yield on his government’s five-year debt surging to 8 percent on speculation a bailout will be tapped, Prime Minister Jose Socrates’s government last week announced new commitments on deficit reduction amounting to 0.8 percent of gross domestic product for this year.

“The measures are not specific enough at this stage to allow us to formulate a clear assessment, but we would not be surprised to see markets put Portugal to the test in the coming weeks,” Goldman Sachs Group Inc. economists including London-based Francesco Garzarelli said in a note to clients.

Portuguese Finance Minister Fernando Teixeira dos Santos said in Brussels today that “our intention is to keep going to the markets.”

‘Powerful Signal’

David Mackie, chief European economist at JPMorgan Chase & Co. in London, says the weekend sent a “powerful signal” that countries willing to do all they can to restore budgetary order will be supported by neighbors and debt restructurings could still be avoided, said.

That leaves the responsibility for ending the crisis with individual countries and whether they can cut budget deficits enough to again enjoy the trust of investors, said Charles Morris, who oversees $2.5 billion as head of HSBC Global Asset Management’s Absolute Return Fund.

Greece, for example, faces a debt that the European Commission forecasts will reach 159 percent of GDP next year and which Moody’s Investors Service last week cut by another three levels. On the eve of last week’s talks its 10-year bond yields rose to a record and it cost more than ever to insure against a default.

“To solve the debt crisis, these countries will have to lower their debt proportion to GDP, and interest rate payments will have to be low,” said Morris. “The measures show leaders are serious about tackling the problem and it will improve sentiment in the near term. It remains to be seen if it will solve the problem. We are not in a hurry to buy bonds from peripheral countries.”


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