German bond auction spooks investors as leaders bicker

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A German bond auction failed on Wednesday, sparking concern the debt crisis could strike at the heart of the eurozone as European leaders bickered about what to do next.

Investors shunned an issue of German 10-year bonds, considered the gold standard of eurozone debt, making bids of only 3.9 billion euros ($5.2 billion) for the 6.0 billion euros of securities on offer.

While Berlin downplayed the outcome, Austria's central bank head and European Central Bank (ECB) governing council member Ewald Nowotny called it an "alarm signal".

The German Finance Agency deemed it a "reflection of the extraordinarily nervous market conditions," and a spokesman insisted it does not mean any refinancing bottleneck.

However the result spooked investors, sending European stocks and the euro sliding.

London dropped 1.29 percent, Paris 1.68 percent and Frankfurt 1.44 percent with other European markets also down sharply and Wall Street following.

The euro declined to around six-week lows at $1.3327 in late afternoon trade, down sharply from $1.3507 in New York late Tuesday.

"There's been a lot of talk lately that perhaps Germany isn't the safe-haven that many people thought it was," said UBS currency strategist Chris Walker.

So far Germany has largely benefitted as investors have sold off their holdings of weaker eurozone government debt and put their money into German bonds, which are seen as a much safer asset.

This safe-haven sentiment has driven down the rate of return for investors to below inflation, meaning investors are in effect taking a loss for the security of holding German debt.

"This failure today should be seen as indication of small appetite for risk and illiquidity," said Saxobank analyst Steen Jakobsen. "It does not raise major concern for Germany but more for the overall state of the funding markets for government."

CMC Markets analyst Michael Hewson said the auction failure "begs the question that if the strongest economy in Europe can't shift 10-year bonds, what does that mean for everyone else in Europe trying to raise funds in the open market?"

The disappointing bond auction came as the EU's executive Commission launched a debate on what some see a solution to this difficulty -- issuing eurobonds that all eurozone members would jointly guarantee.

European Commission President Jose Manuel Barroso unveiled a radical set of reforms designed to toughen the policing of member states' budgets, laying the ground for the potential introduction of so-called eurobonds.

"The goals driving this package -- economic growth, financial stability, budgetary discipline -- are linked to each other," said Barroso. "We need all of them if we are to move beyond the current emergency."

But Chancellor Angela Merkel quickly reiterated Germany's opposition to eurobonds, saying they "will not work."

Germany fears its ultra-low borrowing costs would rise sharply if its debt were pooled with other, less fiscally solid countries such as Italy, Spain and Greece.

Finland and the Netherlands also came out against eurobonds, which critics say will reduce the incentive for weaker countries to implement much-needed reforms to stabilise their public finances.

Germany and France have also sparred over recent days over having the ECB become a lender of last resort in order to resolve the debt crisis.

Paris believes intervention by the central bank -- effectively authorising it to issue new money and buy government bonds on a massive scale to head off the threat of a default by member states -- could end the eurozone crisis.

"The best way to avoid contagion in countries like Spain and Italy is, as far as France is concerned, an intervention or a possible intervention, an announcement that a lender of last resort could intervene, in the form of the European Central Bank," French Finance Minister Francois Baroin said.

But Germany fears that this course could fuel inflation and actually undermine the single currency, and the idea is in any case ruled out under current European Union treaties.

Greece appeared to come closer to unlocking eight billion euros ($10.8 billion) in blocked EU-IMF loans when a holdout party leader wrote Wednesday to Brussels confirming support for lasting reforms but also calling for some tweaks to the country's latest bailout programme.


© 2011 AFP

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