The financial cloud hanging over Europe darkened on Tuesday as the single currency slumped and borrowing costs rose in tandem with investors’ anxiety about eurozone debt.
In the wake of bailouts for Greece and Ireland, political leaders scrambled to end damaging speculation that larger European countries could default and plunge the eurozone into a potentially fatal crisis.
As Spain and Italy — two of Europe’s biggest hitters — saw their borrowing costs rise, European Central Bank President Jean-Claude Trichet tried to face down the speculation.
“Observers are tending to underestimate the determination of the [eurozone] governments and the EU as a whole,” Trichet told the European Parliament.
However, markets gave a cool reaction.
The euro dipped under the symbolic floor of US$1.30 for the first time in more than two months as investors saw further eurozone instability.
At CitiFX, a branch of Citigroup Inc, analyst Valentin Marinov said the fall of the euro signaled “that investors remain more focused on potential contagion to other eurozone countries than they do the situation in Ireland,” which recently agreed to a bailout.
“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,” Marinov said.
That disbelief was visible on Europe’s bond markets on Tuesday.
The yield — the rate of return — on 10-year Spanish debt rose above 5.50 percent from 5.46 percent late on Monday, as the gap between Spanish and German rates reached new highs.
Spainish Deputy Finance Mminister Jose Manuel Campa insisted the gap was temporary as he vowed to press ahead with unpopular deficit-reducing reforms.
“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 said.
Italy too came under market pressure with the spread between its 10-year rates and Germany’s also hitting new highs.
“Objectively, on the basis of Italian fundamentals, the reaction seems excessive,” said Marco Valli, an economist with UniCredit SpA. “But the market is panicking, which could mean that the eurozone crisis of confidence has entered a more dangerous phase.”
News that ratings agency Standard & Poor’s could soon cut Portugal’s credit rating did little to ease jitters.
S&P put Portugal on a credit watch, citing “increased risks to the government’s creditworthiness,” as growth was expected to falter and amid changes to EU rules that could force private bondholders to take on the cost of bailouts.
At Pimco LLC, a fund heavily invested in government bonds, chief executive Mohamed El-Erian, warned “the longer the uncertainty over how investors will participate in losses lasts, the greater the probability that they withdraw from the market.”
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