Pressure rises on Europe as bond sales loom

European leaders return to work this week seeking to buy time for the Spanish and Italian governments to wrest control over their debt and rescue the single currency from fragmentation in its 10th anniversary year.

Some 157 billion euros ($200 billion) in debt will mature in the 17-member euro area in the first three months of 2012, according to UBS.

By the end of that period, leaders have pledged to draft a stricter rulebook for controlling government spending. German Chancellor Angela Merkel and French President Nicolas Sarkozy will meet in Berlin January 9 to work out details.

“The road to overcoming this won’t be without setbacks, but at the end of this path Europe will emerge stronger from the crisis than before,” Ms Merkel said in a New Year’s speech broadcast December 31. Ms Merkel, whose first official public appointment is on January 5, reiterated that her government will do “everything” to bring the euro out of the slump.

Ten years after euro bank notes replaced national currencies on January 1, 2002, the euro has for the first time recorded two consecutive annual losses against the US dollar while plunging to a record low against the yen and the Australian dollar.

That raises the pressure on euro leaders as they struggle to hold the monetary union together in the face of credit downgrades, European Union splits and a looming recession that might compound rising debt.

The latest crack in Europe’s crisis-fighting plans appeared on December 30, when Spain’s new government said 2011’s budget deficit would reach 8 per cent of output, 2 percentage points more than the previous government had projected and more than the 6.9 per cent expected by economists surveyed by Bloomberg. Prime Minister Mariano Rajoy responded by unveiling a new package of spending cuts and tax increases.

Still, the key to the euro’s survival may lie with Italy, the group’s third-largest economy and the second most-indebted after Greece. The government in Rome must repay 53 billion euros in debt in the first quarter, about a third of the euro area’s total amount for the period, after Prime Minister Mario Monti passed an emergency budget package aimed at curtailing borrowing costs.

Italy’s 10-year yield ended 2011 near the 7 per cent mark that led Greece, Ireland and Portugal to seek bailouts. Spain’s equivalent yield finished the year just above 5 per cent. Italian 10-year yields dropped 13 basis points to 6.97 per cent overnight, while Spanish yields were little changed at 5.10 per cent.

“If the Italian yields start to rise, you could quickly turn a manageable situation into an insolvent one,” Michael Spence, a professor of economics at New York University and a Nobel laureate, said on Bloomberg Television December 28. “Italy needs time and Europe needs to help buy them some of the time.”

German Finance Minister Wolfgang Schaeuble echoed that strategy, telling the Bild newspaper yesterday that European rescue funds can only “buy time” before indebted states take “the necessary measures to win back confidence.”

Mr Sarkozy said that the French government will turn from budget fighting to economic growth and unemployment in 2012, which will be “the year of all risks and of all possibilities,” he said December 31 in his fifth New Year’s address, the last before he faces a re-election contest in May. Mr Sarkozy will meet with Italy’s Monti in Paris on January 6.

In his New Year’s message to Greek citizens, Prime Minister Lucas Papademos said his nation will confront a “difficult” 2012 and said that the “next three months will be particularly crucial.”

Mr Papademos, appointed on November 11 as head of a government backed by three of the five parliamentary parties, is trying to secure loans under a 130 billion-euro bailout for Greece agreed to in October by EU leaders before elections are held. Measures include negotiating a debt swap with private creditors that will cut 100 billion euros off Greece’s burden.

As Europe’s leaders tinker at a new budget framework and craft the so-called firewall that will prop up ailing states, Bundesbank President Jens Weidmann said that the European Central Bank won’t “step into the breach for fiscal policy.”

"We have to make it clear where our legal, but also our real limits, are,” Mr Weidmann, who is a council member of the Frankfurt-based ECB, told Tagesspiegel newspaper yesterday.

Fiscal and monetary efforts could be hampered by a shrinking economy in the euro area, which would crimp tax revenues and fuel unemployment. The economy of the 17-nation area will shrink by about 0.7 per cent this year, said Howard Archer, an economist at IHS Global Insight in London.

“We expect eurozone recession to occur in late-2011 and the first half of 2012 in the face of the ongoing eurozone sovereign debt crisis,” Mr Archer wrote in a December 30 note to clients. “It is vital that eurozone policy makers get a real grip on matters quickly.”


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