Thursday, November 11, 2010

Ireland and Portugal Stir New Wave of EU Debt Worry

Ireland and Portugal Stir New Wave of EU Debt Worry


LONDON—Irish and Portuguese bonds came under increased pressure as the dimming fortunes of the euro zone's weaker economies stirred fears that other countries besides Greece may need a bailout.

The selloffs showed that investors increasingly doubt that crisis-hit countries in Europe can pull off big reductions in their budget deficits in the face of stagnating economies without defaulting or being rescued by the European Union or International Monetary Fund.

The difference in yield between Irish 10-year government bonds and safer German debt rose to more than six percentage points for the first time on Wednesday. Ireland's chief central banker conceded that his country's debt is now trading at "crisis levels." A clearing house said it is effectively raising the cost of trading Irish government bonds due to heightened risk of an Irish debt default.

Portugal had to pay a record-high yield of 6.85% to attract investors for an offering of 10-year bonds, adding to the challenges Lisbon faces as it tries to repair its public finances. Still, the yields in the auction were lower than on existing Portuguese bonds trading in the open market, showing that low trading volumes for some European countries' bonds may be distorting the picture somewhat.

The euro sank to its lowest level in one month against the U.S. dollar, dipping below $1.37 before recovering a little. European stocks fell 0.7%.

Investors have refocused on the euro-zone's debt troubles in the past week following news of a Franco-German initiative that could end up forcing bondholders to bear part of the pain in any future bailout of a European country.

Although such a provision wouldn't change the terms of Europe's current bailout facilities, and would affect only government debt issued after 2013, the discussion among EU leaders has unnerved investors concerned about the medium-term prospects for Europe's weakest economies.German Chancellor Angela Merkel and French President Nicolas Sarkozy are pushing for the debt-restructuring provision to be included in the EU's arrangements for dealing with future debt crises. The European Financial Stability Facility, part of a €750 billion ($1.033 trillion) EU-IMF package to support euro-zone members, is expected to expire in 2013.

The yield on Ireland's 10-year bond, which moves inversely to its price, jumped to nearly 9% from 8.16% on Tuesday, a record premium of 6.49 percentage points over the borrowing rate of Europe's safest sovereign borrower, Germany. This premium, which stood at 5.74 percentage points on Tuesday, has jumped for 12 straight days.

Even more worrying, a similar yield premium for Irish two-year bonds also soared to 6.40 percentage points, from 5.06 percentage points on Tuesday. Normally, longer-dated government bonds offer a significantly higher yield, since investors lose more control over their cash when they lend it for longer periods.

The tiny gap between Ireland's yield premiums for two-year and ten-year bonds implies that investors believe the time difference no longer matters because Ireland may quickly prove unable to repay its debt.

"We are getting to the point where people are panicking," says Huw Worthington, an analyst at Barclays Capital in London. "The market is anticipating some sort of [Irish debt] restructuring now," he says. However, he adds that the chance of an imminent Irish default is "zero."

Ireland's jumping bond yields quickly hit bond markets in Portugal, Greece and, to a lesser extent, Spain.

In Greece's latest financial setback, the country appears to be slipping further in its goal of trimming a treacherously high budget deficit. Monthly budget figures released Wednesday by Greece's finance ministry show that central-government revenue rose just 3.7% in the first 10 months of this year, compared with the same period of 2009. Greece's deficit-reduction plan, hammered out in May, calls for a 13.7% increase for the full year. Even a revised plan that offsets lower revenue with more spending cuts foresees an 8.7% gain.

Thanks to the weak revenue performance, Greece said its central-government deficit from January to October was down 30% from the same period last year, falling short of Greece's target of a 32% reduction. The slippage means Greece is unlikely to meet its deficit-reduction target for the year as a whole, unless it takes even further austerity measures.

George Zanias, the chairman of the Finance Ministry's council of economic advisors, says that Greece's efforts to collect more taxes will bear fruit and that spending cuts are offsetting revenue shortfalls. On revenue, "we are behind, however, compliance is increasing," he said in an interview, "and this has not affected deficit targets because we have cut expenditures."

Investor sentiment on Ireland took another blow on Wednesday when European securities-clearing firm LCH.Clearnet raised the amount investors must set aside to trade Irish debt on margin.

Clearing firms stand between buyers and sellers of bonds to ensure that transactions go through even if one party collapses. LCH's decision makes Irish bonds less attractive for investors and thus could make it harder for Ireland to fund itself by selling bonds. However, several analysts said the impact of LCH's move on the trading of Irish bonds won't be dramatic.

Irish bonds were also hit by rumors that the increasingly indebted country, struggling with a banking crisis whose cost to taxpayers could hit €50 billion, has already asked the IMF for aid. However, Irish Finance Minister Brian Lenihan told the country's Parliament on Wednesday that "there has been absolutely no application by Ireland to the IMF and/or the EFSF," the European Financial Stability Facility.

Investors are worried about the stability of Irish Prime Minister Brian Cowen's fragile coalition government, which must pass a crucial austerity package next month. Its majority in Parliament is razor thin.

"The only good news is that Ireland does not need to access the markets in the near term," said Cambiz Alikhani, a partner at London-based asset manager Iveagh Ltd., who doesn't own Irish bonds. Ireland's government has said that it has enough funds to cover government expenses until the middle of next year.

Portugal also faces strong political and financial headwinds, raising concerns about its ability to stick to its deficit-cutting plans.

While Portugal's minority government and its opposition have come to the table lately, Parliament must still approve the budget at the end of the month.

Some investors also now fear that aggressive austerity programs in Ireland and Portugal could actually crimp economic growth, short-circuiting any deficit-cutting by reducing tax revenue.

Still, there has been some good news in recent days. Chinese officials have offered to help Portugal, possibly by buying government bonds, repeating similar moves towards Spain and Greece. And Ireland's manufacturing sector continued to push ahead despite the economy's weakness, according to data released Wednesday.

The large moves in Ireland's bond market may partly be due to limited trading of bonds, which means that even small sell orders cause a huge ripple on prices. "There's no liquidity at all," says Barclays Capital's Mr. Worthington. "Investors are not willing to touch anything at the moment."
—Charles Forelle in Brussels contributed to this article.

Write to Neil Shah at

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