Europe Yield Backup Signals Complacency Bringing New Crisis
European leaders lulled into complacency by Mario Draghi’s pledge to buy their bonds may be stumbling toward the next euro-region emergency.
Policy makers are squandering the decline in borrowing costs triggered by the European Central Bank president’s commitment to defend the single currency, leaving the 17-nation bloc’s economy and financial systems vulnerable, according to economists Charles Wyplosz and Paul De Grauwe.
“I don’t see how we avoid having another acute crisis now that governments are so pleased with themselves,” Wyplosz, director of the International Center for Money and Banking Studies in Geneva, said in a telephone interview. “The wave of optimism we had was unjustified. Key elements of the crisis aren’t being dealt with.”
Concern that political turbulence would deepen backsliding has rattled markets. Ten-year bond yields in Spain and Italy rose this week to their highest of 2013 as Spanish Premier Mariano Rajoy faced opposition calls to resign amid contested reports of corruption in his party and Italy’s Silvio Berlusconi narrowed the front-runner’s lead before elections in three weeks.
Italian government bonds slid today with the yield on 10- year notes rising 1 basis point to 4.47 percent at 12:56 p.m. in Rome. Spain’s benchmark stock index fell 0.3 percent while the country’s 10-year bonds rose.
“The crisis has never been over,” said de Grauwe, a professor at the London School of Economics and a two-time candidate for a seat on the ECB’s Executive Board. “If this reversal goes on we’ll get a new stage and the ECB will have to act or it will lose credibility.”
Triggered by Greece in late 2009, the turmoil that has required 486 billion euros of bailout commitments was brought to heel by Draghi in July 2012. He pledged to do “whatever it takes” to save the euro. In September, he spelled out a program that amounts to an as yet untapped promise to buy the bonds of governments that agree to austerity goals. It worked.
Ten-year yields in Spain and Italy have declined more than 2 percentage points from July. Bets on intrade.com now imply a 13.5 percent chance of a euro breakup by the end of this year, down from 39 percent a year ago.
“The worst, probably, is over,” Luxembourg Prime Minister Jean-Claude Juncker, who had been head of the group of euro-area finance ministers since 2005 before he stepped down last month, said Jan. 10.
Investors have shown they agreed with that assessment. Portugal sold 2.5 billion euros of junk-rated five-year notes last month in the country’s first bond sale since its 2011 bailout. Spain drew record demand for a 7 billion-euro sale of 10-year notes on Jan. 22. Ireland raised fresh funds from investors on Jan. 8.
Even a Greek company was able to borrow. Hellenic Telecommunications Organization SA sold 700 million euros ($948 million) of five-year bonds paying 7.875 percent on Jan. 30, hailing the transaction as “a vote of confidence”.
As markets advanced, the pressure to enact promised policies eased.
Italian Prime Minister Mario Monti watered down labor- market reforms in the face of resistance the country’s biggest union. His Spanish counterpart, Mariano Rajoy, last month extended emergency aid for the jobless and postponed a plan to shrink local governments. Germany and Austria are blocking progress towards banking union by objecting to direct recapitalization through the European Stability Mechanism for struggling lenders.
“Many in Berlin view direct bank recaps through the ESM as a back-door for joint liability and resist them forcefully,” Joachim Fels, chief economist at Morgan Stanley in London, said in a Feb. 3 report to clients. “Politically, this is understandable, but economically it means the negative feedback loop between troubled sovereigns and weak banks won’t be broken.”
Meantime, debts are mounting. Government debt in Ireland, Italy and Portugal will peak this year and in Spain in 2014, according to European Commission forecasts.
Rajoy added more than 3 billion euros to Spain’s debt load in the closing hours of 2012 with a New Year’s Eve order removing a cap on utilities’ government-guaranteed losses.
Spain’s budget deficit probably exceeded 9 percent for a fourth year in 2012 as record unemployment, shrinking output and the bank bailout costs offset almost all of the government’s 62 billion euros of austerity, according to economists at Societe Generale SA and the Madrid-based Applied Economic Research Foundation.
Portuguese revenue is shrinking even as the government increases levies on companies and workers. Tax income dropped 6.1 percent in 2012, the Finance Ministry said Jan. 24.
With a sense of deja vu, International Monetary Fund Managing Director Christine Lagarde has also urged leaders to recognize they’ll have to forgive part of the 240 billion euros pledged to Greece in two aid packages if the country’s finances are to stabilize.
The Washington-based lender also last month cut its outlook for the euro-region economy, forecasting a 0.2 percent contraction this year instead of the 0.1 percent growth it foresaw in October. The IMF also cut its estimates for Germany and France as the recession ravaging peripheral Europe weighs on demand and generates losses for banks.
For Gary Cohn, president of Goldman Sachs Group Inc., the lack of a recipe for renewed growth means Europe still faces “fundamental problems.” Unemployment in Spain and Greece is above 25 percent.
“No one has solved the European economic issue for me yet,” Cohn said in an interview with Bloomberg Television’s Susan Li in Hong Kong yesterday. “No one’s given me an explanation of how we’re really going to create growth in Greece, or in Spain, or in other peripheral countries.”
Credit Agricole SA, France’s third-largest bank by market value, took a 2.7 billion-euro writedown in the fourth quarter to reflect losses on its stake in a Portuguese lender and Deutsche Bank AG took a 1.9 billion-euro charge. Credit Agricole already booked losses from a 2.2 billion euro acquisition of Athens-based Emporiki in 2006.
As losses from the first euro members sucked into the crisis emerge on the balance sheets of the bloc’s most powerful members, Cyprus is trying to persuade German Finance Minister Wolfgang Schaeuble it is large enough to merit the fifth bailout of the crisis. The German government may stall for as long as three months, Fels said.
“Many in Berlin don’t believe that Cyprus is a systemic risk,” he said. “I worry about a resurfacing of worries about bail-ins for bank creditors in Cyprus and even about euro exit which could easily lead to another bout of the euro crisis.”
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