Don’t Cancel Vacation Plans Yet Over Espirito Santo Woes

Don’t cancel those vacation plans yet.

The drop in European stocks and Portuguese bonds doesn’t augur a return of the euro crisis -- which forced leaders to cut short their holiday in August 2012. Even Greece sold bonds today, though at yields higher than some analysts predicted amid the skittishness triggered by a delayed note payment by a company linked to Lisbon-based Banco Espirito Santo SA.

“The current perception is that this is an isolated incident, but it’s caused some nervousness,” Jim Reid, a strategist at Deutsche Bank AG in London, told clients in a morning report.

The fear is that Espirito’s woes suggest those of the euro area have been on pause and that investors becalmed by the recent lull in financial markets are ripe for renewing volatility.

The cost of insuring financial debt in Europe rose, with the Markit iTraxx Financial Index of credit-default swaps on 25 European banks and insurers reaching 74, the highest since May 27, according to data compiled by Bloomberg.

So why not press the panic button?

Mainly because European Central Bank President Mario Draghi remains on his “whatever it takes” war footing to bolster the euro. The ECB has gone further to support its economy since the crisis peak, cutting interest rates and offering banks new loans just last month while refusing to rule out quantitative easing.

‘Safety Net’

“This is the ultimate safety net,” says Holger Schmieding, chief economist at Berenberg Bank. “It is now stronger than it was when inflation was less subdued.”

Meantime, the crisis-torn European nations also are much improved. Economic sentiment in the periphery last month reached its highest since January 2008, exports are gaining, unemployment is falling and domestic demand is stirring.

More support may be pending. Banks are being subjected to tougher stress tests, the passing of which may encourage more lending, while governments are opening up more fiscal room so long as laggards take measures to fix their economies.

As for Portugal, it has just exited its aid program and its government’s reforms have helped cut unemployment and supported economic growth. The government can finance itself although if it needed outside assistance for its banking sector it could likely follow Spain in drawing on European funds for that without too many demands being placed on it, said Schmieding.

“We see no reason to turn bearish on the euro zone,” he said. “Short-term corrections in markets can happen.”

Before it's here, it's on the Bloomberg Terminal.