EUROPEAN BONDS STABILIZE AFTER A NOD OF SUPPORT FOR IRELAND / THE NEW YORK TIMES ( A MUST READ )

November 12, 2010

European Bonds Stabilize After a Nod of Support for Ireland

By LANDON THOMAS Jr. and JAMES KANTER

LONDON — Shaken European bond markets recovered slightly on Friday, helped by a joint statement from finance ministers of the European Union’s biggest economies that the group stood ready to provide assistance to Ireland.


But even as Irish sovereign bonds recovered some of their recent losses, the continued weakness of the euro highlighted growing investor concern that the market unrest over Ireland and Portugal was a symptom of a broader problem. Investors are worried about the widening fissure between the more feeble countries of the euro zone and an increasingly dominant Germany.


In a statement during the Group of 20 economic meeting in Seoul, the ministers from Britain, France, Italy, Spain and Germany sought to persuade spooked investors to stop selling Irish bonds, emphasizing that the rule changes being considered for future bailouts would not result in write-downs for current bondholders.


Ireland’s finance minister, Brian Lenihan, who is trying to pull together a four-year plan to cut the country’s gaping deficit, said on Friday that he welcomed the support. He added that Ireland had not asked for any help from the European Financial Stability Facility or from the International Monetary Fund.


The yield on the Irish 10-year bond eased somewhat, to 8.5 percent on Friday, after touching a high near 9 percent on Thursday. The euro was almost unchanged against the dollar, at $1.37.


Europe hopes that the public words of support for Ireland, together with next week’s visit by a delegation from the monetary fund and the European Union, will be enough to persuade investors that the 16-country euro zone is ready to confront the problems among its weakest economies.


But the original impetus behind the proposed debt restructuring changes — the deep distaste expressed by Germany’s chancellor, Angela Merkel, for her country’s current position as the main guarantor of the 440 billion euro, or $604 billion, stability fund — suggests that divisions within the bloc persist. The fissures seem especially evident now that Ireland, Portugal and perhaps even Spain may have to use the fund within the next year or so.


Adding to the uncertainty is a dawning awareness of how just widely the debt of weaker members is held. According to Jacques Cailloux, an analyst at Royal Bank of Scotland, banks outside Greece, Portugal and Spain hold 2 trillion euros of their debt, or 22 percent of the gross domestic product of the 16 euro countries. With Irish debt included, the figure surpasses 2.25 trillion euro, or $3.09 trillion.


So while Mrs. Merkel’s push for investors to share the burden of propping up weak economies may be driven by domestic political concerns, the ramifications — investor unrest and increasing doubts about the ability of European leaders to act quickly and with authority — could be global in scope.


The fear of a European split between a fast-growing center and a group of nations stagnating on the geographic and economic periphery was underscored on Friday by figures showing that the euro zone economy grew 0.4 percent in the third quarter. But there was disparity in that data: Germany’s economy grew 0.7 percent, while Portugal improved just 0.2 percent and Greece’s economy shrank by 1.1 percent.


Of primary concern to analysts was the Spanish growth figure, zero percent for the quarter, which was announced a day earlier.


The spread, or yield gap, between Spanish and German bonds widened Friday to 2.3 percentage points. The increase followed a fairly long period during which Spanish bonds traded in line with those of countries like Italy and France — and not with stragglers like Ireland and Portugal.


But the stagnation in Spanish growth, as well as recent data that show its real estate prices falling, bank debts increasing and unemployment rising beyond its current 20.8 percent, provide a grim reminder that the stability of Spain — the fourth-largest country in the euro zone — is crucial to the zone’s future.

Variant Perception, a research company based in London that has written extensively on Spain, warned in a recent report that “although it is still too early to say if Spain will be the straw that broke the camel’s back and led to the disintegration of the European Union, it is clear that its problems are far from tractable.”


The report points out that distressed loans in the Spanish banking sector are now 5.6 percent of total loans, the highest amount since 1996. Banks in Spain, unlike their peers in Ireland, have been very slow to recognize real estate losses and have instead taken commercial and domestic properties onto their balance sheets in the hope of selling them.


But the continued decline in real estate prices has made that task difficult and, under pressure from domestic regulators, losses are being recorded, although nowhere near the level of Ireland.


And while Spain is likely to meet its deficit target this year — bringing it down to 9.3 percent of gross domestic product from 11 percent, the goal of 6 percent for next year will be much harder to achieve.