European Squabbling on Crisis Tests Rally as Spain Bonds Decline

German Finance Minister Wolfgang Schaeuble
Wolfgang Schaeuble, Germany's finance minister. Photographer: Jock Fistick/Bloomberg

Squabbling among European governments over the next steps needed to overcome the sovereign debt crisis raised the specter of more turmoil, puncturing a rally that had sent Spanish 10-year bond yields to their lowest in five months.

A Sept. 14 European Union finance ministers meeting in the Cypriot capital of Nicosia deadlocked over the timetable for a more unified EU banking sector, with a German-led coalition pushing back against a more ambitious plan sought by France, Spain and Italy. The ministers also bickered over the terms of bailout requests and the role of the European Central Bank.

“Experience suggests that just as day gives way to night, improvement gives way to policy complacency, which is then followed by renewed crisis,” Joachim Fels, chief economist at Morgan Stanley in London, wrote in a note yesterday.

The euro area’s ability to overcome differences will determine whether a market revival prompted by increased ECB intervention and a German high-court ruling on bailout funding will mark a turning point in the three-year-old crisis or just the latest European bid for more time.

Governments “mustn’t disappoint markets” in their banking-supervision design, German Chancellor Angela Merkel said today at press conference in Berlin. “It’s not about putting something out that once again won’t work in the end.”

The indecision in Cyprus sparked a drop in Spanish government bonds, with two-year yields climbing 14 basis points to 3.27 percent at 12:50 p.m. in Madrid. Ten-year yields climbed 11 basis points to 5.89 percent, 420 basis points more than comparable German notes. The euro slid 0.1 percent to $1.3117 after climbing 1.1 percent on Sept. 14, helped by new measures by the U.S. Federal Reserve.

Single Supervisor

The sharpest EU disagreement in Nicosia was over a European Commission plan to establish joint banking supervision from the beginning of next year. German Finance Minister Wolfgang Schaeuble, backed by colleagues from Sweden, the Netherlands and Poland, urged the meeting to agree on a more cautious approach when assigning new duties to the ECB.

EU leaders called for a single supervisor in June as a condition of bailout assistance directly to euro-area banks. Such a mechanism would be designed to decouple government funding to prop up failing credit sectors, breaking the link between sovereign and banking debt that has been blamed for compounding the crisis.

While Schaeuble argued that such a “sizable apparatus” would require more time to take in more than 6,000 euro-area financial institutions, other finance ministers wanted to stick to the Commission’s timetable.

“We can’t waste time,” French Finance Minister Pierre Moscovici told reporters in Nicosia.

Rajoy Meeting

Shuttle diplomacy will continue this week, culminating with back-to-back high-level meetings, as Spanish Prime Minister Mariano Rajoy travels to Rome for talks with Italian Prime Minister Mario Monti on Sept. 21. The next day, Merkel will hold talks with French President Francois Hollande at a commemoration in Ludwigsburg, Germany.

An initial test of market confidence could come in Spain, where Rajoy is considering whether to request further euro-area assistance, an issue that’s sparked further division. Schaeuble last week cautioned Spain against seeking a full bailout, countering pressure from France. The country “would be daft” to ask for a bailout on top of the 100 billion euros ($131 billion) for its banks if it didn’t need it, Schaeuble said.

Spanish Steps

Rajoy’s government will unveil new measures by the end of the month based on recommendations made in July, including a possible increase in the retirement age, shifting from labor to consumption taxes and deregulating closed professions, according to European officials. Spanish Economy Minister Luis de Guindos in Nicosia reaffirmed the country’s ambition to cut its deficit to 6.3 percent of GDP this year from 8.9 percent.

Such measures are giving rise to a growing backlash in Spain, with union leaders demanding a referendum on budget cuts as 65,000 protesters marched in Madrid over the weekend.

“It’s time to give a voice to the people again,” Comisiones Obreras General Secretary Ignacio Fernandez Toxo, a union leader, told protesters blocking the center of the capital. “With the support of the people we will take this as far as the government wants us to. This doesn’t end here.”

In Greece, the government continued its bid to win more leeway to meet its obligations to the country’s troika of international creditors -- the Brussels-based Commission, the ECB and the International Monetary Fund.

European officials in Nicosia, concerned that a confrontation with Athens could up-end the reform drive and sully the market bounce, signaled that Greece may get its way.

Troika Delay

“Greece has already produced a huge effort but will have to continue to do so,” IMF Managing Director Christine Lagarde told reporters during the Nicosia meeting. “There are various ways to adjust. Time is one. That needs to be considered as an option.”

The troika’s verdict on Greece’s progress, which will determine whether the country where the crisis originated continues to receive funding, was put off until October, possibly coinciding with a leaders’ summit in Brussels.

Merkel said today her “heart bleeds” at the hardships faced by many Greeks as the government in Athens imposes the austerity measures demanded for the bailouts.

To be sure, some analysts predicted that the market rebound will likely be extended even amid the current euro scuffling. Erik Nielsen, global chief economist at UniCredit Bank AG in London, said that attention in coming months could shift away from Europe and toward the election and budget fight in the U.S. and the leadership transition in China, as that country confronts a slowdown in growth.

“I think this rally still has some weeks to run,” Nielsen wrote in a note to clients yesterday. “The capital misallocations driven by (irrational) fear were so big that it almost certainly takes more than a couple of weeks to correct.”