Debt crisis hits heart of eurozone, ECB extends lifeline

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The European Union said the debt crisis is now striking at the heart of the eurozone and the central bank threw out lifelines on Thursday, but stocks plunged.

Financial markets are alarmed about debt strains in the United States even though the debt ceiling has been raised, and in the eurozone, and the overall drag these add to already faltering growth.

European and US stocks slumped more than 3.0 percent after the ECB statements, and after European Commission President Jose Manuel Barroso raised the alarm to a new pitch, saying "we are no longer managing a crisis just in the euro-area periphery."

The extent and range of ECB help was unclear, particularly regarding acute market pressure on Italy, the third-biggest eurozone economy and on Spain, the fourth.

Spain risked a bond issue to raise 3.0-4.0 billion euros but again had to pay investors much increased interest rates, and late in the day it cancelled an issue scheduled for August 18.

Barroso, having warned of market scepticism about "the systemic capacity of the euro area to respond" to the crisis, urged all EU leaders urgently to revisit their rescue defences.

Created in the last 18 months, these were ramped up just two weeks ago to help Greece a second time and contain contagion.

CMC markets economist Michael Hewson said: "Disappointing economic data on both sides of the Atlantic, as well as surging Italian and Spanish bond yields, has seen risk appetite plummet as pessimism about global recovery starts to take hold with a vengeance."

Barroso's alarm call was followed by action and vague statements by the ECB, which was under market pressure to provide extra help by resuming purchases of government bonds.

This was needed to avert "the biggest banking crisis since 1931", in the words of one analyst.

The ECB said it would return to six-month loan facilities to help some cash starved segments of the eurozone banking system.

And ECB president Jean-Claude Trichet said that the bank had not interrupted its bond-buying programme. Market sources said that the bank was now visibly purchasing in the secondary market after what they said was an 18-week pause.

The ECB, holding its key rate at 1.5 percent, also signalled concern about possible inflationary pressures while suggesting that growth might be trending on the weaker side of expectations.

In Italy, Prime Minister Silvio Berlusconi said his government would come up with a wide-ranging pact for growth by September, following talks with employers and trade unions.

A joint statement after their talks calling for liberalisation, privatisation and labour reforms, said: "The situation is grave. It must be confronted ... without excuses or shortcuts."

New measures would be in addition to a crisis budget package of 47.9 billion euros ($68.6 billion) adopted last month to ward of market pressure.

Spanish Prime Minister Jose Luis Rodriguez Zapatero has delayed his holiday to fight the crisis, but has not announced any new measures.

Global stock markets have fallen heavily recently, with investors seeking the flight of safety to gold, the yen, Swiss franc and German bonds.

"It's all doom and gloom for the markets at the moment," said Simon Denham, head of Capital Spreads trading group.

In the United States, attention is focused on weak growth and the deficit despite the last-minute raising of the debt ceiling which immediately pushed debt above 100 percent of gross domestic product.

Thursday unemployment data was unencouraging and jobs data on Friday was expected to cast more gloom over growth.

Investors are also tracking the credit rating agencies which warn that they are watching the US debt-growth combination closely, and in case the renewed strains in the eurozone trigger new ratings warnings.

Goldman Sachs economist Dirk Schumacher said before the ECB statement that the central bank did not want to fund governments, "but things are different in a liquidity crisis where there is a risk of systemic events."

Citi Economics analyst Willem Buiter said that "the ECB will have to come in or accept a couple of fundamentally unwarranted large sovereign defaults and the biggest banking crisis since 1931."

In London, the Centre for Economics and Business Research commented: "Realistically, Italy is bound to default but Spain may just get away without having to do so."

© 2011 AFP

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