FRANKFURT (MNI) – Debt woes in the Eurozone periphery may once
again play a central role in the European Central Bank’s exit
considerations, given rising market tensions and contagion risks
emanating this time from Ireland.
Worries about peripheral countries’ ability to weather the crisis
without tapping aid or restructuring debt, coupled with concern about
efforts by Germany and France to make private creditors contribute to
any future Eurozone bailouts, continued to drive bonds spreads higher on
Thursday.
In unusually candid remarks, Irish central bank governor Patrick
Honohan on Wednesday warned that current sovereign borrowing costs for
Ireland are unsustainable, adding to fears that Ireland will have to tap
the European Financial Stability Facility.
“I’ll readily say that the current rate is well above the rate at
which one would go back in [to the markets]. It is “unsustainable and
you couldn’t imagine them going forward,” Honohan said.
In contrast to the Irish government, Honohan did not exclude the
option of Ireland turning to the IMF for help but merely said that he
did not think the IMF would impose a plan that was very different from
the current one outlined by the government.
German daily Handelsblatt reported Thursday, citing German
government sources, that rising bond yields had induced EMU governments
to prepare a contingency aid plan for Ireland. Late Thursday, rumors
circulated in financial markets that EMU states were putting the final
touches on a E48 billion Irish bailout package. However, a spokesman for
Eurogroup President Jean-Claude Juncker denied the reports and rumors.
“There is no meeting, no conference, no discussion,” the spokesman, Guy
Schuller, said, adding that the topic could not be discussed unless and
until Ireland requested aid.
As for Greece, already receiving aid from its neighbours and the
IMF, Executive Board member Juergen Stark said Thursday that the fiscal
consolidation program is “on track,” and that he believes “Greece will
be able to master the situation with the support.”
This suggests that officials from the European Commission, the ECB
and the IMF, due to arrive in Athens Monday, will likely approve the
payout of an addition E9 billion tranche from the Greek loan package.
But the latest news of a much larger-than-forecast 2010 fiscal deficit
(9.3% vs 7.9%), based on information from the government’s budget report
as well as from the media, is likely to feed fears of eventual debt
restructuring needs.
Fresh sovereign debt jitters forced the ECB to jump back into the
sovereign debt market last week, after three weeks of abstinence, to buy
governments bonds worth some E711 million. According to traders, the ECB
has continued its buying spree this week in the face of spiraling
tensions and bond spreads.
It is not hard to see how heightened tensions could also force the
central bank to keep liquidity flowing. Persistently high spreads on
peripheral bonds will not make it any easier for addicted banks —
largely based in peripheral countries — to get back into the good
graces of interbank markets.
“The borrowings of Irish banks from the ECB are very large,”
Honohan said Wednesday after warning that the speed at which they will
be able to wean themselves off central bank liquidity support will
depend on narrowing spreads.
The problem of addicted banks has thus far been enough to slow the
ECB’s exit from extra liquidity support, and along with the exacerbation
of the crisis comes the increased risk of contagion affecting the wider
system. Financial institutions outside these countries are estimated by
researchers at the Royal Bank of Scotland to hold some E2 trillion in
debt securities of Greece, Ireland, Portugal and Spain.
The timing for the agreement on a permanent Eurozone crisis
resolution mechanism, due in December, may be key for ECB policy going
forward. The ECB may yet want to keep maximum flexibility in early
December when announcing its liquidity framework for the subsequent
months, in order to deal with any potential fallout from the
still-outstanding decision.
This is particularly true if Germany’s proposal for an orderly
default mechanism should appear to be materializing. Executive Board
member Lorenzo Bini Smaghi called the proposal “a recipe for disaster”
and Honohan observed that it has already probably “destabilised the
markets,” contributing to the sharp spread widening of recent days.
With 3-month Euribor above still above the ECB’s 1% fixed rate, the
central bank may well still announce a return to competitive bidding in
its 3-month operations starting in the first quarter — since keeping
rates on its refinancing operations below market levels would discourage
interbank deals. However, unless tensions subside significantly, the ECB
is likely to tread very carefully and, at the very least, offer generous
allotment amounts.
Perhaps unsurprisingly then, Executive Board member Jose Manuel
Gonzalez-Paramo reminded that “it is perfectly possible, if we see signs
or upward risks to price stability, to move interest rates before
withdrawing all the extraordinary measures. It is a possibility that
does not take much to imagine.”
Gonzalez-Paramo also said that there are no inflationary pressures
at the moment, thus making current rates appropriate. Super hawk Juergen
Stark, however, observed that monetary policy has become increasingly
accommodative relative to the progressive economic stabilization, while
Thursday’s Monthly Bulletin noted that ECB’s policy contains elements of
a “leaning against the wind.”
No doubt, the next rate hike remains in the distant future, but it
is nevertheless worth noting some early hawkish comments coupled with
repeated warning against keeping interest rates too low for too long,
even if President Jean-Claude Trichet declined to reiterate that warning
during last week’s monthly press conference.
In other comments, ECB Council members continue to insist that they
have no reason to believe that the U.S. Federal Reserve is pursuing a
weak dollar policy, even as former Fed chairman Alan Greenspan argued
that the U.S. is pursuing such a policy, just like China.
Christian Noyer argued that while the U.S. economy is notably below
its long-term growth potential, the euro area is “relatively close to
its potential,” thus seeming to justify the policy divergence between
the ECB and the Fed.
–Frankfurt newsroom +49 69 72 01 42; e-mail: jtreeck@marketnews.com
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