Tuesday, 12 July 2011 16:50

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Markets rocked as debt crisis deepens

Europe's debt crisis escalated on Monday as Italy and Spain saw their borrowing costs soar by record amounts, hitting bank shares and stock markets globally.

Italy, the eurozone's third-largest economy and home to the continent's biggest bond market, saw the premium it pays to borrow over German debt rise by more than a quarter to 3 percentage points, a euro-era high. Spain's benchmark borrowing costs rose above 6 per cent, also a euro-era high.

The sharp market moves came as a consortium of large European banks with holdings of Greek bonds demanded that the European Union commit itself to a buy-back of the debt, possibly with billions in government money. Without quick action, they warned, countries such as Spain and Italy could be sucked under.

"It is essential that euro area member states and the [International Monetary Fund] act in the coming days to avoid market developments spinning out of control and risk contagion accelerating," said a six-page paper presented to eurozone finance ministers by the banks on Monday.

Late on Monday night, the ministers attempted to respond to the pressure, announcing at the close of an eight-hour meeting that they had reopened the possibility of using the eurozone's €440bn bail-out fund to repurchase Greek debt on the open market.

 The move had previously been blocked by Germany and the Netherlands, but could cut Greece's debt burden significantly.

Market participants described the day as one of the most dramatic of the 18-month-long crisis and warned that Europe's current policy would probably be unable to deal with Italy, which has €1,600bn ($2240bn) of outstanding debt, if it becomes fully ensnared. "Once Italy gets involved it starts to be a situation that politicians alone may not be able to solve," said Jim Reid, credit strategist at Deutsche Bank.

Shares in Italian banks -- the largest holders of the country's sovereign debt -- came under further pressure with Intesa Sanpaolo down 8 per cent and Unicredit off 6 per cent after the Italian market regulator forced investors to disclose their short-selling positions. Intesa and Unicredit's shares are down 20 per cent and 25 per cent respectively in the past 8 days.

The proposal by the Institute of International Finance, representing the banks, which was obtained by the Financial Times, would vastly expand the scope of the Greek bail-out and could see billions in taxpayer money used to buy up swaths of Greek bonds at discounted levels.

"Market deterioration in the last few days underscores the fact that a comprehensive approach is needed immediately to contain contagion and avoid a global financial crisis," the document said.

Banks have for weeks been negotiating through the IIF with European officials over proposals that they shoulder as much as €30bn of a new €115bn Greek bail-out by exchanging their current bond holdings for new, longer-maturing debt. But the new proposal appears to make banks' agreement contingent on the buyback plan, which the IIF says is essential to lower Greece's overall debt burden and return the country to fiscal health.

Benchmark borrowing costs for Italy and Spain -- as measured by 10-year bond yields -- rose 0.44 percentage points for Italy to 5.72 per cent and by 0.41 percentage points for Spain to 6.09 per cent, the highest one-day moves in at least a decade. German benchmark yields fell 0.16 percentage points, their biggest fall in two years, to 2.67 per cent.

Stock markets fell globally with the S&P 500 down 1.6 per cent in midday New York trade, France's CAC 40 off 2.7 per cent and the FTSE 100 in London slipping 1 per cent.

World Business News.