FRANCE CUTS FRANTICALLY AS ITALY NEARS DEBT SPIRAL / THE TELEGRAPH.COM.UK ( VERY HIGHLY RECOMMENDED READING )

Financial Crisis

France cuts frantically as Italy nears debt spiral

France has unveiled the toughest austerity measures since World War Two despite the looming danger of a double-dip recession, vowing to slash borrowing by €65bn over the next five years in a last-ditch effort to save the country's AAA rating.

French Prime Minister Francois Fillon delivers a speech to announce the government's austerity measures plan in Paris on Monday. Photo: Bloomberg

By Ambrose Evans-Pritchard, International business editor

9:23PM GMT 07 Nov 2011 720


"We wish to protect the French against the grave problems facing other European countries. Bankruptcy is not an abstract word," said premier Francois Fillon.

The belt-tightening plan -- the second package since August, taking total cuts to €112bn -- include a 5pc super-tax on big firms, a rise in VAT on restaurants and construction, and cuts on pensions, schools, health, and welfare. It is the latest squeeze in a relentless campaign of fiscal tightening across the eurozone.

"It is like the 1930s: imposing austerity on countries already in recession is the way into a death spiral," said Danny Blanchflower, a former UK rate-setter.

Left-wing critics have evoked grim parallels with the "deflation decrees" of Pierre Laval in 1935 when France had to take ever harsher measures to preserve the country's viability on the Gold Standard, a gamble that ultimately set off violent street protests.

France's move came amid a further blizzard of grim data from Europe, confirming that most of the region is already on the cusp of recession. Growth has reached a "virtual standstill", said EU commissioner Olli Rehn.

Eurozone retail sales fell 0.7pc in September from the month before. German industrial output plunged 2.7pc, the steepest drop since the depths of the crisis in January 2009. Factory orders fell 12pc.

Mr Fillon said the country must accept sacrifice to "avoid the day where policies are imposed upon us by others," insisting that France would meet its "untouchable" deficit target of 4.5pc of GDP next year -- down from 5.7pc this year.

The austerity plan seems aimed at insulating France from the unfolding disaster in Italy, where a deepening slump and the final agonies of Silvio Berlusconi's government sent debt markets into a tail-spin on Monday.

Rome was a seething cauldron of rumours, plots, and threats all day long as Mr Berlusconi furiously denied claims by insiders that he was about to resign and ordered "traitors" in his own party to look him in the eyes. He faces a confidence vote on Tuesday.

Yield spreads on 10-year Italian bonds spiked to a post-EMU record of 491 basis points over German Bunds. Crucially, they reached 424 points over the benchmark AAA basket used by LCH Clearnet to fix margin requirements. The exchange has in the past raised the bar once spreads reach 450 and stayed there for a few days. "The markets will price in financial systemic risk once we get to this level," said Andrew Roberts from RBS.

The escalating crisis threatens the rest of Europe through bank exposure. Mediobanca said Europe's 20 biggest banks hold €186bn of Italian sovereign debt, led by Intesa SanPaolo (€64bn), Unicredit (€39bn), BNP Paribas (€23bn), Dexia (€13bn), Commerzbank (€9bn), and Crèdit Agricole (€8bn).

Goldman Sachs warned that Italy might start to take "unilateral decisions" such as seizing banks or clamping down on the bond market (effectively holding investors captive) if the political climate deteriorates further and authorities feel boxed in. It said the crisis has set off a "self-fulfilling dynamic" that may ultimately make it impossible for Italy to roll over debt.

The EU's bail-out fund (EFSF) does not yet have the firepower to halt the crisis by purchasing Italy's bonds. The fund itself struggled to raise money in a €3bn auction on Monday, paying 177 points over Bunds -- up from 51 in June.

"The EFSF is basically doomed to be worthless," said professor Giuseppe Ragusa from Rome's Luiss Guido Carli University. Investors are wary of its shifting mandate. There is suspicion for EU plans to leverage the fund to €1 trillion as a "first loss" insurer of bonds, which concentrates risk.

Mr Ragusa said surging yields have already imply an extra €7.6bn in extra debt payments. Rome must raise €260bn next year. "The European Central Bank is the only answer. If Berlusconi goes and there is a technocrat government, the ECB may be willing to step in and save Italy," he said.

The ECB was undoubtely a buyer yesterday but held back from overwhelming action, risking a deadly metastasis of the crisis. Board member José Manuel González-Páramo issued a blunt warning that Italy can expect no white knight. "The ECB is not a lender of last resort. It does not have a magic wand."

Joachim Fels from Morgan Stanley said Europe's leaders may themselves have invited disaster by suggesting for the first time that a country -- Greece -- may be pushed out of EMU. This shatters the stated orthodoxy until now that the euro is inviolable and eternal.

"They may have set in motion a sequence of events which could potentially lead to runs on sovereigns and banks in peripheral countries that make everything we have seen so far in this crisis look benign," he said.