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EU will discuss crisis mechanism as ECB grapples with banks

Published 13/12/2010 | 10:18

European Union leaders will this week discuss the creation of a permanent mechanism to shore up over-indebted countries as the European Central Bank tries to hammer out plans to aid the region’s weakest lenders.

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At a summit in Brussels on December 16 and 17, the group will confront investor skepticism about its readiness to stem a sovereign-debt crisis that led to bailouts for Greece and Ireland and threatens to spread.

Spain’s 10-year bonds fell for the past five sessions and the nation will further test investor appetite for its debt when it sells bonds this week.

“I don’t think there’s anything they can come up with to settle things down right away,” said David Owen, chief European economist at Jefferies International Ltd in London.

“The problems will continue. Markets are very much focusing on the first few weeks of next year when not only sovereigns but banks need to go to the market for a lot of financing.”

German Finance Minister Wolfgang Schaeuble told ARD Television yesterday he expects an EU agreement on a permanent crisis facility.

Meanwhile ECB officials are focusing on how to reduce banks’ reliance on emergency liquidity measures, according to comments last week by Governing Council members Mario Draghi and Yves Mersch.

EU officials are considering measures that would allow the region’s rescue fund to buy bonds of distressed governments, the Financial Times reported today, citing people involved in the meetings. They are also considering allowing short-term credit lines to nations struggling to borrow but not in need of bailouts, the paper said.

Merkel’s comments

German and French leaders have pledged to do whatever is necessary to defend the currency. The euro’s survival is “non- negotiable,” requiring budget vigilance and closer economic cooperation to overcome “structural weaknesses” within the region, German Chancellor Angel Merkel and French President Nicolas Sarkozy said on December 10 after a meeting in the German town of Freiburg.

Spanish bonds may fall this week in the run-up to the summit amid speculation auctions may underscore rising concern Europe’s debt crisis is deepening. The nation is due to sell bonds maturing in 2020 and 2025 on December 16.

Investors may also focus on Italy, where Prime Minister Silvio Berlusconi faces a no-confidence vote. Lawmakers in Rome begin debating a no-confidence motion at 9am and the voting, scheduled for tomorrow, will determine whether Italy’s richest man can sustain his government, whose term still has two years.

The yield premium on Italy’s 10-year debt over comparable German bunds more than doubled this year, reaching a euro-era high of 212 basis points November 30. It ended last week at 160 basis points.

Perception of Italy

“Italy needs to be looked at carefully,” said Owen, who noted that with debt equivalent to 116pc of output as a concern. The reality is that “if the markets perceive that Italy has a problem, then Italy has a problem.”

A sovereign default in Europe could throw the entire region back into recession, Ernst & Young said in a report released today.

“The euro zone’s political leadership is confronted with an existential challenge to the well-being” of the region, Ernst & Young Partner Mark Otty wrote.

Any further spreading of the debt crisis may increase pressure on the ECB to step up its bond-purchase program.

“The problem is that that various parties with the ECB are very reluctant to do that,” Owen said. “The question is whether events will overtake them.”

ECB officials are discussing measures to deal with banks overly reliant on central-bank funding, Governing Council member Mario Draghi said last week.

The ECB is debating “concrete proposals” for such banks, Draghi said, according to the Financial Times. Such steps would be part of the ECB’s exit strategy, he told the paper.

“We clearly have the phenomenon that some banks are dependent on ECB refinancing,” Governing Council member Yves Mersch, who is also head of Luxembourg’s central bank, told Neue Zuercher Zeitung in an interview published December 11. “This is being worked on at the moment and we will probably present a solution at one of our next meetings.”

Bloomberg

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