The whiff of contagion swept through the eurozone once again yesterday. On the eve of a crucial summit of EU leaders in Brussels supposedly focused on averting a humanitarian catastrophe in Libya, the fate of the euro has provided an unwelcome distraction.
In a move that may have fateful ramifications for the eurozone, the credit ratings agency Moody's downgraded Spain yesterday by one notch to Aa2, with a "negative" outlook, estimating that restructuring the savings banks will cost more than double the government's €20bn (£17bn) forecast.
Referring to the cost of rescuing Spain's cajas, smaller regional banks heavily exposed to the property crash, the agency said it "believes there is a meaningful risk that the eventual cost of the recapitalisation effort could considerably exceed the government's current projections", putting the cost at €110bn to €120bn. Spain's highly autonomous provinces are also said to be an obstacle to fiscal discipline.
Last week, Greece was pushed to "junk" B1 status, on a par with Fiji and Vietnam. With demands by the Irish government to renegotiate the terms of their EU/IMF bailout and no sign that Europe's leaders are close to detailed agreement on rescue procedures, yields on most eurozone sovereign debt spiralled on renewed fears that, sooner or later, Portugal and Spain will need a bailout, or that Greece or Ireland will have to "restructure" or default on the debts – or some apocalyptic combination that would overwhelm the European Financial Stability Facility (EFSF). A Spanish emergency, in particular, is feared because it would be so costly.
The euro fell to a one-week low of $1.3804, the risk premium on Spanish bonds over safe German Bunds widened again and the cost of insuring Spanish, Greek and Portuguese debt against default jumped as a fresh bout of near-paranoia swept markets.
The yield on benchmark 10-year bonds is well over 12 per cent for Greek paper, and 7.5 per cent for Portugal – both unsustainable given their poor growth prospects and sizeable debts. There is also concern that their fiscal austerity programmes may reduce their chances of growing their way out of trouble. Soaring global oil and other commodity prices have also undermined those economies' ability to survive.
While issues such as a no-fly zone in Libya will dominate the day, Europe's leaders are expected to support the outline deal brokered by France and Germany that would impose tougher fiscal rules and commitments to reform economies in distressed nations in return for a beefed-up bailout fund. However, no final decisions are due before another leaders' summit on 25 March. The best hope is for an "agreement in principle": "The quicker we get a deal, the quicker we calm the markets," a diplomat said.
Other sources yesterday agreed that there may be no breakthrough at today's talks. On the question of the future of the EFSF, a German official counselled that his government "does not believe it is the right time to discuss this".
German officials have reiterated their determination to make their weaker neighbours reform their economies to close the competitive gap between Germany and most of the "peripheral" economies. They remain opposed to so-called "Eurobonds" where the German taxpayer would have to stand behind other nations' debts. A "package" of reforms is essential. Nor are they opposed in principle to an Irish renegotiation.
The Germans, and the European Central Bank (ECB) are also adamant that supportive purchases of sovereign debt by the ECB should be wound down. The heavy hint by the ECB president, Jean-Claude Trichet, that ECB rates would be increased next month has also been taken as a signal of that.Reuse content