Bank warns on sovereign debt after Ireland denies approach to IMF for bailout

Markets and investors have become less optimistic about the state of Europe's finances over the last month, the Bank of England warns today. Its Quarterly Bulletin reveals that while the resolution of the most acute stage of the sovereign debt crisis in the spring prompted an increase in confidence amongst market professionals during June and July, pessimism returned in August.

The Bank's warning is in tune with the mounting concern that the eurozone crisis is on the verge of breaking out again, with Ireland's government forced to deny that it was intending to call in the International Monetary Fund to bail it out. That denial was prompted by a sharp spike in the cost of insuring Irish sovereign debt, which followed heightened speculation about Ireland's ability to stay on top of its public finances while also bailing out its crisis-hit banks.

The Bank warns that there is little chance of these anxieties easing in the short term, with investors also feeling more worried about whether the economic recovery now under way in almost all European countries can be sustained.

"Concerns about sovereign default risk in some European countries persisted with sovereign credit default swap premia for these countries remaining elevated," the Bank warns. "Moreover, despite robust economic growth in the first half of the year, doubts about the speed and durability of the global economic recovery grew, particularly following weaker-than-expected US macroeconomic data."

The Bank's warning underlines fears expressed widely in recent weeks that a faltering in the economic recovery could plunge many countries back into crisis, with markets remaining extremely sceptical about the viability of their deficit reduction plans. Many of the southern European members of the single currency bloc are seen as especially vulnerable, but a repeat of the crisis earlier this year would be felt across the continent.

"The UK economy continues to recover from the effects of the financial crisis," said Spencer Dale, the Bank's chief economist. "But that adjustment has been slow and painful."

This week, the Bank is due to release the minutes of its September meeting of the Monetary Policy Committee, which opted to both interest rates and the quantitative easing programme on hold. The MPC has come under mounting pressure to change tack, both from those who advocate a tightening of policy to tackle inflation fears, and from others who want to see policy loosened further to address the ongoing anxiety about the sustainability of the recovery.