Europe’s money markets freeze as crisis escalates in Italy and Spain
The European money markets have begun to seize up as pressure mounts on the Italian and Spanish banking systems, tracking the pattern seen during the build-up towards the financial crisis in 2008.
The three-month euribor/OIS spread, the fear gauge of credit markets, reached the highest level in two years today, jumping 7 basis points to 40 in wild trading.
“Europe’s money markets are undoubtedly starting to freeze up,” said Marc Ostwald from Monument Securites.
“It’s not as dramatic as pre-Lehman but it is alarming and shows the pervasive degree of fear in the markets. People are again refusing to lend except on a secured basis.”
The credit stress was triggered by fresh mayhem in the southern European bond markets and ominously in parts of the eurozone’s soft core as well, including Belgium. Spanish yields pushed further into the danger zone to 6.42pc. Italian debt reached a post-EMU high of 6.22pc before falling back slightly on reports of Chinese buying.
“We have a revolt taking place by foreign investors in these bond markets,” said Hans Redeker, currency chief at Morgan Stanley. “There have been hardly any purchases for several months. We are seeing net disinvestment because people fear that these countries lack the potential to grow their way out of the problem, and risk falling into a Fisherite debt trap.”
Mr Redeker said the eurozone needs a lender-of-last resort along the lines of the US Federal Reserve to backstop the Spanish and Italan bond markets. The European Central Bank cannot easly step into the breach under its current legal mandate and treaty authority.
“The eurozone faces a very big decision: it either creates a central fiscal authority or accepts reality and starts to think the unthinkable, which is to cut the currency union into workable pieces.”
The escalating drama forced Spain’s premier Jose Luis Zapatero to delay his holiday in the Doñana biodiversity park near Huelva. A spokesman said he was staying in Madrid “to more closely monitor the evolution of the economic indicators”. Mr Zapatero telephoned opposition leader Mariano Rajoy on his holiday in Galicia to keep him informed of the fast-moving events.
In Rome, Italy’s president Giorgio Napolitano held a second meeting in days with central bank chief Mario Draghi, the future head of the ECB. There has been speculation in the Italian press that the well-respected Mr Draghi might be called to lead an emergency government to restore market confidence.
Finance minister Giulio Tremonti invoked the country’s financial crisis committee on Tuesday as the Milan bourse fell to a three-year low, once again led by bank stocks. Fiat fell 6pc after an 11pc drop in Italian car registrations in July.
Mr Tremonti was to talk last night to EU economics commissioner Olli Rehn, who has interupted his holiday in Finland. He will visit Luxembourg on Wednesday for a meeting with Eurogroup chief Jean-Claude Juncker.
An EU spokesman said there was “no emergency plan” on the table. “There are no factual reasons that we are aware of that can explain this sudden acute surge in spreads. What matters is that the Spanish and Italian authorities are taking the necessary action towards fiscal consolidation,” she said.
Simon Derrick from the BNY Mellon said the trigger for the final denouement in each of the eurozone’s bond crises so far has been when the spread over German Bunds reaches 450 basis points, prompting LCH Clearnet to impose higher margin requirements. The Spanish spread hit a record 400 on Tuesday.
The political ferment behind the scenes points to a major policy shift, though it is unclear what the EU authorities can do without the full backing of EU leaders. They are mostly on holiday and German Chancellor Angela Merkel does not like to be bounced into decisions.
The EU summit accord in late July has clearly failed to reassure investors. It gave the EFSF bail-out fund powers to buy Spanish and Italian bond pre-emptively but this has to be ratified by all parliaments, which may take four months. Willem Buiter from Citigroup said the €440bn fund is far too small to cope with Italy and Spain, and requires immediate firepower of €2.5 trillion. Such demands risk setting off a political crisis in Berlin.
Credit experts in the City said it was unlikely that China is purchasing bonds from the eurozone periphery. The Chinese central bank’s reserve manager SAFE is clearly buying euros on a large scale to hold down the yuan and safeguard export advantage in Europe, but it appears to be purchasing short-term debt of a one-year maturity or less and other liquid assets.
Even if the crisis is resolved, Italy and Spain may have to pay significantly higher borrowing costs to attract buyers. Anthony Peters from Swissinvest says large clients have been telling asset managers to eliminate Sourthern European risk. “They have kissed peripheral Europe good-bye,” he said.