Olli Rehn: Dire warning of 2012 double-dip recession
THE debt crisis picture darkened considerably today with a warning from EU Economics’ Commissioner Olli Rehn that Europe faces slipping back into recession in 2012.
EU officials now fear that the scale of Italy's economic woes will pose bail-out problems for the eurozone which will make the Greek crisis look like a sideshow.
Germany today categorically denied that it was pursuing the idea of a smaller eurozone.
Angela Merkel’s spokesman said a Reuters report that German and French officials have discussed plans that could involve some of the weaker countries leaving the 17-nation currency bloc was untrue.
The German government is most definitely not pursuing such plans," spokesman Steffen Seibert said.
"On the contrary, our policies are aimed at stabilising the eurozone in its entirety and attacking the root of its problems," he added.
The reports of discussions came amid fears that a debt default by Greece or even Italy could sink the eurozone and cause chaos on financial markets.
"Growth has stalled in Europe, and there is a risk of a new recession," Mr Rehn said as the EU released detailed forecasts for the eurozone and broader economy for the next two years, with GDP "now projected to stagnate until well into 2012."
The EU said that growth across the eurozone in 2012 will collapse to 0.5pc, a steep drop from its previous forecast of 1.8pc.
Mr Rehn demanded that France make deeper deficit cuts and warned Belgium, Cyprus, Hungary, Malta and Poland that they were not doing enough to cut their deficits.
“Further financial turmoil may have more substantial spill-over effects to other market segments and the real economy. It may ignite stronger and more harmful adverse feedback loops than currently expected. The forecast depends crucially on the assumption on current challenges being successfully addressed. Should the response to the challenges lack timeliness, clarity or ambition, a more negative development and a relapse into recession cannot be excluded,” he said.
Italy today sold €5bn of one-year bonds at an average yield of 6.087pc – a record high and way above the 3.57pc available to them before the crisis took hold.
Italy’s bond yield slipped below the critical 7pc mark, but analysts said it was too little too late.
Stock markets across the world have opened sharply down and the Spanish and German 10-year yield spread today widened to a euro-era record.
The European Central Bank was today reported to be buying Spanish bonds in a bid to bring the interest rate down as it did with Italian bonds.
On the markets the FTSE 100 opened down 1.8pc. RBS the biggest faller, off 5pc. Spain's IBEX was down 1.5pc and Italy's MIB was down 1.4pc. Germany's DAX was down 1.7pc, France's CAC was down 2.1pc. France has banned short-selling on shares for a further three months.
Greece is set to announce its new prime minister today, but for all the continuing drama and nail-biting over the state of Greece, the country's economy represents only a tiny fraction of the gross domestic product (GDP) of the 17 eurozone countries.
Italy, on the other hand, is the third largest economy in Europe.
"If it goes the way of Greece, it will be impossible to bail it out," said one EU official.
"To use the latest glib phrase, Italy is too big to fail - but it could."
Italian Prime Minister Silvio Berlusconi will step down "within a few days" the country's president Giorgio Napolitano announced this morning.
“Within a short time either a new government will be formed... or parliament will be dissolved to immediately begin an electoral campaign,” he said.
The BBC's business editor Robert Peston stressed that even a little bit of give by Germany would take the pressure off Italy: “This all comes back to Germany. It can at least take the crisis down a few notches by saying it's prepared to commit some of its substantial resources. a statement of that sort would be immensely helpful.
“Today we've seen contagion to the implied price of Spain and France to borrow - there is a genuine risk that the eurozone is unraveling before our eyes and it's down to Germany to prevent that,” he said.
Concern rose yesterday as Italy's borrowing cost reached a new high, with interest rates above 7pc being demanded.
The interest rate jumps reflect continuing uncertainty over the fate of the government and the economy, with prime minister Silvio Berlusconi insisting on hanging on in power until austerity measures are in place.
Officials in Brussels say he failed to heed economic warnings early enough and should go immediately - not least because a false rumour earlier this week that he had quit made markets soar.
A 7pc borrowing charge was the point at which bailouts were required for Greece, Ireland and Portugal - but the sums required to prop up the Italian economy would be in a different league altogether.
An existing EU bailout fund of €440bn has already been whittled down to about €250bn by rescue packages so far for the first three governments.
And although an EU summit last month agreed to "leverage" the existing fund to one trillion euro to cope with bigger-scale economic collapses, there is no agreement on how to boost the kitty more than four-fold without adding more cash to the pot.
One Brussels-based economist explained: "It's all about financial engineering, and using the existing bail-out capital to raise the effective value of the fund.
"The problem is most people think that even if there is leveraging to one trillion euros, it will not be enough to convince markets that Europe has the firepower to tackle any potential economic disasters.
"The markets want to see a number more like two trillion - or even three."
Number-crunchers estimate an initial bailout for Italy might cost about €650bn to ease a debt burden of €1.9 trillion.
Talks between EU finance ministers on how to leverage the current bailout fund this week did not resolve the problem, with disagreement on how to attract interest among investors through discounted bond-buying programmes or other incentives for public and private funding - including from wealthy nations such as China.
Another alternative is to allow open-ended lending from the European Central Bank (ECB) - something Germany deeply opposes for fear it would give the ECB a licence to print money and fuel inflation.
"The problem is that we must find a formula for support that satisfies the markets of our capacity to contain this problem - but that is what we have been saying for 18 months now," said an EU diplomat.
"In the case of Italy, the most obvious and immediate way to take the heat out of the crisis is simple - get rid of Mr Berlusconi tonight."
But he added: "Unfortunately, that is a remedy that can be deployed once."
Stan Shamu, a strategist at IG Markets, added: "The fact that Angela Merkel is now working on a plan to make it possible for European nations to exit the euro area shows a shift in dynamics for Europe.
"After the problems experienced with Greece, such a plan would make it easier for EU leaders to deal with a crisis in the future. In the near term though, this is likely to rock the boat further."