German finance minister Wolfgang Schauble said there will be no more money until Greece "actually does" what it agreed to do. "I understand that there is resistance among the Greek population to austerity measures. But in the end it is up to Greece whether it can fulfil the conditions necessary for membership of the common currency. We offer no discounts," he told Deutschlandfunk. The wording has been taken as a threat to eject Greece from EMU, though is there no legal mechanism for such drastic action.
Dutch finance minister Jan Kees de Jager said the Netherlands "will not participate" in further payments to Greece unless it secures the go-ahead from the EU-IMF Troika, which left Athens abruptly last week after talks broke down.
The showdown in Greece came as the European Central Bank (ECB) abandoned its push for higher interest rates and slashed growth forecasts for the next two years, warning that the situtation is "extraordinarily demanding" and that "downside risks" have intensified.
"The hiking cycle has been aborted," said Carsten Brzeski from ING, adding that rates may even be cut from 1.5pc if the economy worsens and deflations rears its ugly head.
Jennifer McKeown, at Capital Economics, said the ECB will have to cut rates twice over the next six months as the global downturn deepens. The bank raised rates in July even though eurozone growth had already ground to halt, a move widely deemed to be a policy error.
Willem Buiter from Citigroup said the ECB must cut rates immediately to shore up Italy and Spain. "As long as they are willing to walk down the hill again as swiftly as they walked up it I don’t think any lasting damage was done. They have to change course," he told Reuters.
Jean-Claude Trichet, the ECB’s president, said the bank had been given a clear mandate by "the democracies of Europe" to hold inflation below 2pc and has stuck to its task. "We have delivered price stability, impeccably. I want to hear congratulations," he said in an emotional defence of the bank.
The ECB cut its growth forecast for next year to 1.6pc from 1.9pc, and to just 1.3pc in 2013, implying a long slump that will leave the eurozone’s weakest economies trapped in recession with crippling unemployment. The downgrade comes as the OECD club of rich states issued its own grim outlook, predicting that Germany’s economy would contract in the fourth quarter of this year.
Credit default swaps (CDS) on Greece have risen to record highs and two-year debt yields have reached 47pc as markets braced for the "endgame" of a long-running saga. "There is no threat of Greece exiting the eurozone," said Greek spokesman Ilias Mosialos, insisting that the country will deliver on key reforms.
The tough line on Greece reflects hardening opinion in northern Europe rather than egregious backsliding by the Greek government of George Papandreou, who inherited the current mess. Swingeing austerity has itself caused the economy to spiral downwards and miss targets. Output shrank at a 7.3pc rate in the second quarter of this year, a dire outcome after almost two years of recession. Barclays Capital said the budget deficit may remain stuck at 9pc this year.
The Greek parliament's own watchdog said the debt dynamic is "out of control". Public debt will reach 172pc of GDP next year. The policy of an IMF-style austerity package without the usual IMF cure of debt restructuring and devaluation appears to have tipped the economy into 1930s debt-deflation. The self-evident failure of the strategy makes it extremely hard for Mr Papandreou to secure democratic consent for further cuts.
Harvinder Sian from RBS said the sovereign humiliation of Greece by EU creditor states smacks of colonialism and can expect to meet fierce resistance. It may be tempting for Greece to precipitate a "hard default" before the second rescue package comes into force and switches a large stock of debt contracts from Greek law to English law, he said.
It is not clear who is in the stronger position in the latest round of brinkmanship between Greece and the German bloc. If pushed too far, Greece can set off a powderkeg. The International Monetary Fund says European banks are highly vulnerable and need to raise their capital by €200bn. Many of the weakest are in Germany.
The Greek crisis has spilled over into Cyprus, raising the risk that a fourth country will soon need an EU bail-out. The island’s finance minister Kikis Kazamias said he is mulling a request for help from the ECB after 10-year Cypriot bonds rose above 13pc. "We do not have the luxury of being choosy about who is going to lend to us," he said.
While Cyprus is too small to be systemically important, its banking system is roughly nine times GDP with liabilities of €156bn, according to Fitch Ratings. This is equivalent to Iceland before it blew up. Cypriot banks have 40pc of their assets in Greece, and hold a significant chunks of Greek debt.
The ECB is facing brushfires across a string of countries. Traders say it intervened yet again on Thursday to stabilize Italy’s debt markets, acting to prevent spreads over German Bunds nearing the danger level of 400 to 450 basis points where LCH Clearnet raises margin requirements.
The bank has already accumulated more than €129bn of Greek, Irish, Portuguese, Spanish and Italian debt. It may be near its political limits within a few more weeks, given open protest from Germany’s Bundesbank.
The ECB is buying the bonds on an understanding that Europe’s €440bn bail-out fund (ESFS) will take over the task once its revamped powers are ratified by all parliaments, which could drag on until next year.
Barclays Capital said Italy and Spain have already slipped back into industrial recession, ratcheting up the pressure. The question is what will happen if the global economy fails to stabilize quickly.
Italy faces €62bn of debt redemption this month, and €170bn by the end of December. The ECB’s ordeal by fire may yet be ahead.
The Telegraph
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