There were rumours flying around Whitehall this morning that the EU leadership was
feeling the strain from yesterday’s rise in Spanish and Italian borrowing costs. Both stand rather too close to 7 per cent for comfort, and the price of insuring against sovereign default in
the two countries also soared to its highest level in two weeks. The limited progress made after the Greek deal of 21 July seems to have been undone.
In fact, the problems stem from the piecemeal deal to allow Greece to selectively default. As I wrote at the time:
‘The European Central Bank has declared that it is happy to allow this and will continue to accept government bonds in the event of sovereign default. This is a major retreat from its earlier position and commentators are clear that the Eurozone is now flirting with contagion. Measures are being prepared to deal with that eventuality. Point 7 on the agenda emboldens the EFSF (the euro’s emergency bailout fund) to intervene in markets in order to recapitalise banks in the event of default on sovereign debts.’
Markets doubt that the European Financial Stability Facility can contain the crisis at present. A spokesman from Nomura told the Dow Jones earlier this morning:
‘The market doesn’t see any backstop being activated in the short term, as we know the new role of the EFSF will probably take months to be adopted and be effective. There will be some implementation risk and that is what the market is concerned about.’
As ever during this crisis it seems, the European Commission is reacting to the markets rather than pre-empting them. Earlier this morning, President Barroso at last conceded that contagion is spreading beyond the periphery of the Eurozone, and urged governments to ratify and bolster the EFSF (and also its predecessor, the EFSM). But there is little he can do as parliaments are in recess, which means that the market’s certainty of uncertainty will continue.
There are also those who believe that the EFSF will prove insufficient, even if Barroso works a miracle. Paul de Grauwe writes in today’s FT:
‘Yet the EFSF will never have the necessary credibility to stop the forces of contagion – precisely because it cannot actually print money. It depends for its resources on the member countries of the union, and these are limited. As a result, it cannot guarantee that the cash will always be available to pay out sovereign bond holders even if its resources are doubled or tripled. Only a central bank that can create unlimited amounts of cash can provide such a guarantee.’
If pressure contains to drop on Spain and Italy, then Barroso et al will have to think again. Perhaps they will come to rue being so indecisive earlier in the crisis.
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