European debt crisis reopens as Italy, Spain under cosh in bond sell-offs
THE euro area debt crisis re-erupted last night amid fears that Italy and Spain are in danger of being priced out of the debt markets.
Political leaders in both countries cancelled holidays and called emergency talks to address the crisis that reignited fears of new and bigger euro area bailouts for the first time since European leaders reached agreement to contain the crisis on July 21.
Spanish prime minister Jose Luis Rodriguez Zapatero cancelled a planned holiday to remain at work yesterday after the country's cost of borrowing over 10 years hit a record 6.455pc yesterday.
In Italy, finance minister Giulio Tremonti called a meeting of the country's Financial Stability Committee, which is drawn from the government, the central bank, market regulator Consob and the county's insurance authority.
Italian prime minister Silvio Berlusconi is due to deliver a speech today setting out plans to revive growth and tackle the country's finances.
Borrowing costs for both countries are rising as investors worry that already low growth prospects will fall further after weaker US figures point to a general economic slowdown.
That would hurt their ability to repay already high levels of government debt.
Fears over Italy and Spain have also reignited this week because of a lack of progress after the deal agreed on July 21 by heads of government from the euro area countries.
European Council president Herman Van Rompuy said the rises in borrowing costs were "astonishing because all macro-economic fundamentals point in the opposite direction".
He said yesterday that Italy would generate a primary surplus in 2011, while Spain's debt was below the EU and euro area average, adding it was ludicrous that the cost of insuring Italian and Spanish bonds against default was among the highest for any country.
Credit analyst Elizabeth Afseth, of Evolution Securities, said Italy and Spain were being hit by a general risk aversion.
"The debt ceiling crisis in the US is an issue -- if the US is downgraded what about France and so on?" she said.
"For fund managers the risk of taking a loss if you hold onto the bonds is greater than any reward they might get if the situation improves," she said.
Investors dumped risky bonds in favour of lower risk German government debt. Demand for the German bonds was so high yesterday it pushed the yield, or return, to less than the rate of inflation for the first time in decades.
The yield on German 10-year bonds fell to 2.395pc, compared to annual inflation of 2.4pc. It means it's costing investors to own the bonds.
Global player Merrill Lynch said yesterday that it had not bought bonds from Greece, Portugal, Ireland, Spain or Italy since April 2010.
It's all a far cry from the euro area deal announced in July which was presented as a comprehensive package to contain the crisis, but it was left to finance ministers and parliaments to agree and implement the details of the plan. That process has stalled because of the August holidays.
It means the European bailout funds have not been able to make the kind of market calming interventions allowed under the plan.
The cost of borrowing over two years is now higher for Italy than for Spain, a sign investors think it's in even worse shape.
Italy is the second biggest borrower in Europe and needs to refinance €900m of debt over the next three years. If its borrowing costs continue to rise, the debt burden will not be manageable and European bailout facilities are far too small to cope with an Italian crisis. (Additional reporting Bloomberg)