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E&Y Says Greek Default Seems Unavoidable; Sees Risk of Recession

A Greek default is inevitable and there is 35 percent chance of the euro-area economy slipping back into recession, Ernst & Young said.

“The euro zone sovereign-debt crisis shows no sign of abating,” E&Y said in an e-mailed report in London today. “A default on Greek government debt now seems unavoidable. The key question is when this default will occur and how it will be managed.”

European leaders have struggled to allay investor concerns that a potential debt restructuring in Greece will plunge the region’s economy into a recession. Greek bonds have tumbled and insurance against default has soared as markets put the probability of insolvency at more than 90 percent. Former European Central Bank chief economist Otmar Issing told Germany’s Stern magazine that the country “won’t get back on its feet without a drastic debt restructuring.”

Experts from the European Commission, the European Central Bank and International Monetary Fund will return to Athens today as officials try to put in place a package of measures that will ring-fence Greece and prevent the turmoil from spreading to countries such as Italy and Spain.

“Authorities have been slow in trying to tackle the problems facing Greece, Ireland and Portugal,” E&Y said. “It was hoped that the rescue package for Greece announced in July would bring to an end the long period of indecision and uncertainty.”

ECB Rate Cuts

E&Y said euro-region gross domestic product may rise 1.6 percent this year instead of a previously projected 2 percent, before slowing to an “anemic” 1.1 percent in 2012. The ECB will cut borrowing costs this year and in early 2012, bringing the benchmark to 1 percent from a current 1.5 percent, according to the report.

“The ECB should lower interest rates to below 1 percent should the eurozone fall back into recession,” it said. It’s “the only institution with some room for maneuver since governments cannot or do not want to relax fiscal policy.”

European leaders agreed at a July 21 summit on a second aid package for Greece that will include contributions from investors and are aimed to strengthen the powers of the euro region’s rescue fund. European Commission President Jose Barroso said yesterday that authorities “should do everything possible” for a faster creation of a permanent fund.

E&Y said the European Financial Stability Facility should be boosted to cover the financing needs of Spain and Italy, a move that it said would require an almost 700 percent increase on its current 450 billion-euro ($613 billion) lending capacity.

“The sovereign-debt crisis is likely to worsen further, in turn undermining growth prospects,” said Marie Diron, an economist at Oxford Economics and adviser on the E&Y report. “A deeper default than the one in July on Greek sovereign debt now looks unavoidable.”

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