In the shadow of Greek elections

June 14, 2012

Italy, rapidly moving centre stage after the euro zone’s failure to assuage markets with a 100 billion euros Spanish bank bailout, faces a crunch bond auction. Having paid four percent to borrow for a year yesterday, it is likely to fork out over five percent for three-year paper although the smaller than usual target of up to 4.5 billion euros means the sale should get away. It will also issue a smattering of 2019 and 202 bonds.

Technocrat prime minister Mario Monti’s honeymoon period is over with even some he would have considered allies decrying the slow pace of his reform programme. Already this week he has appealed to Italy’s fractious political parties for support in keeping the austerity show on the road.
Today, Monti hosts France’s Francois Hollande. They agree on a lot – the need for a stronger growth strategy, a banking union established sooner rather than later and a longer-term goal of euro zone bonds. Berlin, with the possible exception of the first goal, definitely does not.

Moody’s slashed Spain’s rating to just one notch above junk last night. The power of the ratings agencies to shock is significantly diminished but if Spain’s sovereign rating drops further, more of whatever non-Spanish bank private investors are left will be forced to head for the exits. Moody’s noted that the bank bailout will increase Spain’s debt burden and the dangerous of loop of damaged banks being the main buyers of Spanish government debt which is falling in value. It repeated its warning that euro zone ratings could be cut further if Sunday’s Greek election were to increase the chances of that country leaving the euro.

We interviewed EU competition chief Almunia late yesterday who said Spain may need to wind down one of its bailed-out savings banks and later we get data on how much Spain’s banks borrowed from the ECB last month.

On Greece, plans must be afoot for the aftermath of the election. It looks likely that the bloc will give Athens an extra year to make the spending cuts demanded of it if there is any sort of government which will continue with the bailout. Spain has just been granted the same with Germany’s blessing. PASOK leader Venizelos asked for precisely that while New Democracy chief Samaras wants two years more.
Most sane judges think a third bailout and a fundamental reappraisal of the austerity programme will be needed to stop Greece falling off the rails at some point, but there’s not much prospect of that coming quickly. And what will the ECB do? Presumably it stands ready to prime Greek banks with even more liquidity.

There are many good reasons to keep Greece in the euro zone even if it did default – not least the chaos that would ensue, resulting in an essentially failed state that would have to be flooded with aid. Cyprus added to the list yesterday, saying it may look to Russia and China rather than Europe for money to prop up its banks which have been holed below the water line by their exposure to Greece. That would be a move of huge geopolitical implications. If Greece contemplated the same it would be even more so.

Interestingly, Washington in the guise of Treasury Secretary Geithner is urging the rest of the euro zone to get behind Germany’s push for fiscal union, calling for a maximum of clarity on the plans as early as possible. In a distinct change of tone, he said it was unfair to look at Germany as the sole source of the problem. Expect much more on this at next week’s G20 though doubtless Merkel will come under serious pressure as well.

On the safe haven side of the equation, the Swiss National Bank holds its quarterly policy meeting just a few days before Greek elections which could conceivably put unbearable upward pressure on the Swiss franc. No action is expected ahead of the event, but it’s quite possible that the SNB may mention steps such as capital controls or a charge on sight deposits – the cash commercial banks hold with the central bank. Last month, as markets grew increasingly anxious about Athens’ future in the currency bloc, the SNB had to expand its forex reserves by nearly a third to make the currency cap it imposed last year stick.

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