IMF Sees Euro Crisis at Critical Stage, Sees Bank Stress

The euro area crisis has reached a “critical stage” and member nations must make a “strong commitment” to the shared currency to stop the plunge in investor confidence, the International Monetary Fund said in a report that recommended issuing common debt as one solution.

“Despite extraordinary policy actions, bank and sovereign markets in many parts of the euro area remain under acute stress, raising questions about the viability of the monetary union itself,” the Washington-based organization said in a report today. “The financial and economic environment continues to deteriorate. Investors are withholding funding from member states most in need, moving capital to safe havens and driving risk premiums to new records.”

Europe’s monetary system needs a closer union of its banks and more fiscal integration to “arrest the decline in confidence engulfing the region,” the IMF said. A “strong commitment” to the monetary union would restore faith in the shared currency, the organization said.

The Stoxx Europe 600 Index declined 0.5 percent to 248.4 at the close, after earlier climbing as much as 0.3 percent and dropping as much as 0.8 percent. The benchmark measure has fallen 8.8 percent from its high on March 16 amid concern that Greece will have to leave the euro currency union.

Immediate Priority

“The immediate priority is concrete action toward a banking union for the euro area,” the IMF report said. “The proposed EU framework for harmonized national bank resolution processes is a necessary first step. But it needs to go further. A deposit guarantee scheme needs to be established at the regional level to help break the links between domestic banks and their sovereigns, and support depositor confidence.”

Spanish bond yields jumped at an auction in Madrid today with the government paying 4.706 percent to borrow for two years, compared with 2.069 percent at a similar auction in March. Spain’s 10-year yields reached a euro-era record of 7.285 percent on June 18 while Italy’s benchmark yields surged to 6.342 percent on June 14, the most in about five months.

“Introduction of a limited form of common debt, with appropriate governance safeguards, can provide an intermediate step towards fiscal integration and risk-sharing,” according to the IMF.

While monetary policy doesn’t offer a “lasting solution,” falling inflation gives the European Central Bank room to ease policy rates and signal a “commitment to a more accommodative stance for a prolonged period,” the report said. The ECB also must ensure that its monetary support is effective across the region, and it should keep providing “ample liquidity support to banks” under flexible conditions.

If necessary, unconventional policy measures should be used, the IMF said, and the central bank should consider non-standard measures such “some form of quantitative easing” or re-activating the Securities Markets Program.