Eurozone debt crisis deepens

PARIS, France—The financial cloud hanging over the eurozone darkened Tuesday, with the euro falling and Italy hit by rising borrowing rates as EU measures to control sovereign debt left investors uncertain and anxious.

The euro fell under 1.30 dollars for the first time since mid-September, dropping at one point to 1.2969 dollars from 1.3121 dollars late Monday. The single currency later edged back up to 1.2982 dollars.

Upward pressure intensified on 10-year borrowing rates for countries seen at risk of needing a rescue after Greece and Ireland, with attention focused on Spain, a potentially much bigger problem for the EU.

The yield—the rate of return—on 10-year Spanish bonds rose above 5.50 percent from 5.46 percent late on Monday and for fellow struggler Portugal to 7.072 percent from 7.0 percent.

The gap between Spanish and benchmark German borrowing rates at one stage widened to 3.0 percentage points, an all-time high.

The differential is a “short-term fluctuation,” Spain’s Deputy Finance Minister Jose Manuel Campa insisted Tuesday.

“We cannot react to fluctuations of one or two days on the market, especially at times when, given the market tensions, there is a perception that liquidity is smaller than in normal market conditions,” he said.

“These are short-term fluctuations. We are currently in a period of turbulence. What is important is to execute planned policies and the markets will respond,” he added.

Spain’s Socialist government has introduced politically sensitive measures aimed at reviving the economy and slashing its public deficit, including an overhaul of the country’s rigid labor market rules.

Italy too was under pressure on Tuesday, with the spread between its 10-year rates and those of Germany coming to 2.0 percentage points, likewise for the first time.

Italian bond yields rose to 4.687 percent from 4.638 percent on Monday.

“Objectively, on the basis of Italian fundamentals, the reaction seems excessive,” said Marco Valli, an economist with UniCredit bank.

“But the market is panicking, which could mean that the eurozone crisis of confidence has entered a more dangerous phase,” requiring possible intervention by the European Central Bank.

ECB President Jean-Claude Trichet meanwhile sought to soothe fears raised by the Irish debt crisis in remarks to the European Union’s parliamentary committee on economic and monetary affairs.

He said both Greece and Ireland were solvent, insisting that the eurozone economy was “functioning” and had grown by more than expected this year.

Trichet said that “observers are tending to underestimate the determination of the (eurozone) governments and the EU as a whole.”

Markets have given “a big thumbs-down to the steps announced by the European authorities at the weekend,” said Lee Hardman, an analyst at The Bank of Tokyo-Mitsubishi UFJ in London.

In addition to approving an 85-billion-euro (111-billion-dollar) rescue for Ireland, European Union ministers outlined measures under which sovereign debt could eventually be re-structured—but bondholders may have to bear some of the costs of future bailouts.

“A taboo was lifted when the Europeans (ministers) on Sunday said that sovereign debts could be restructured after 2013, which signals that bondholders could no longer be protected,” said bond strategist Nordine Naam at Natixis bank.

Hardman said “the poor bond market reaction is an indication that the market is worryingly losing confidence in the European authorities’ ability to deal effectively with the eurozone sovereign debt crisis.”

At Pimco, a big fund heavily invested in government bonds, chief executive Mohamed El-Erian, said: “My concern is that indecisive management of problems in Greece and Ireland might lead investors to sell sovereign bonds issued by peripheral (eurozone) states as a preventive measure.

“The longer the uncertainty over how investors will participate in losses lasts, the greater the probability that they withdraw from the market” for government bonds, El-Erian said.

Trichet agreed that markets needed greater clarity from EU political leaders, in particular regarding the possibility that investors would suffer losses in the event that a eurozone country defaulted on its debt.

Trichet said rules agreed to last weekend by eurozone finance ministers would be “fully consistent with IMF policy” and would not automatically demand that private investors bear losses.

“These rules are no less and no more than those which already exist at a global level,” he noted.

At CitiFX, a branch of Citigroup, analyst Valentin Marinov said the fall of the euro “signals that investors remain more focused on potential contagion to other eurozone countries than they do the situation in Ireland.”

“A failure from the euro to rally on this development (the Irish rescue) suggests investors do not believe the package goes far to averting strains in countries such as Portugal and Spain.”

Ratings agency Standard & Poor’s Tuesday placed Portugal on a credit watch because of “increased risks to the government’s creditworthiness,” due to the Portuguese government not doing enough to enact “growth-enhancing reforms” and from proposed changes to European Union rules that could mean private bondholders are last in line to be paid back. –Agence France-Presse