Eurozone debt crisis deepens

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The financial cloud hanging over the eurozone darkened Tuesday, with the euro falling and Italy facing rising borrowing rates as EU measures to control sovereign debt left investors uncertain and anxious.

The euro fell under 1.30 dollars for the first time since mid-September, dropping at one point to 1.2969 dollars from 1.3121 late Monday. The single currency was later trading at 1.2982 dollars.

Upward pressure intensified on 10-year borrowing rates for countries seen at risk of needing a rescue after Greece and Ireland, with particular attention focused on Spain as the size of its economy puts it in a far bigger problem category.

The borrowing rate for Spain at one point rose above 5.50 percent from 5.46 percent late on Monday and for Portugal to 7.072 percent from 7.0 percent.

The gap between Spanish and benchmark German borrowing rates widened to 3.0 percentage points, an all-time high.

The differential is a "short-term fluctuation," Spain's Deputy Finance Minister Jose Manuel Campa insisted Tuesday.

"We cannot react to fluctuations of one or two days on the market, especially at times when, given the market tensions, there is a perception that liquidity is smaller than in normal market conditions," he told reporters.

"These are short-term fluctuations. We are currently in a period of turbulence. What is important is to execute planned policies and the markets will respond," he added.

Spain's Socialist government has introduced politically sensitive measures aimed at reviving the economy and slashing its public deficit, including an overhaul of the country's rigid labour market rules.

Italy too was under pressure on Tuesday, with the spread between its 10-year rates and those of Germany coming to 2.0 percentage points, likewise for the first time.

Italian bond yields jumped to 4.687 percent from 4.638 on Monday.

"Objectively, on the basis of Italian fundamentals, the reaction seems excessive," said Marco Valli, an economist with UniCredit bank.

"But the market is panicking, which could mean that the eurozone crisis of confidence has entered a more dangerous phase," requiring possible intervention by the European Central Bank.

Markets have given "a big thumbs down to the steps announced by the European authorities at the weekend," said Lee Hardman, an analyst at The Bank of Tokyo-Mitsubishi UFJ in London.

In addition to approving an 85-billion-euro (111-billion-dollar) rescue for Ireland, European Union ministers outlined measures under which sovereign debt could eventually be re-structured, signalling that bondholders may have to bear some of the costs of future bailouts.

"A taboo was lifted when the Europeans (ministers) on Sunday said that sovereign debts could be restructured after 2013, which signals that bondholders could no longer be protected," said bond strategist Nordine Naam at Natixis bank.

Hardman added that "the poor bond market reaction is an indication that the market is worryingly losing confidence in the European authorities' ability to deal effectively with the eurozone sovereign debt crisis."

At Pimco, a big fund heavily invested in government bonds, chief executive Mohamed El-Erian, said: "My concern is that indecisive management of problems in Greece and Ireland might lead investors to sell sovereign bonds issued by peripheral (eurozone) states as a preventive measure."

"The longer the uncertainty over how investors will participate in losses lasts, the greater the probability that they withdraw from the market" for government bonds, El-Erian said.

At CitiFX, a branch of Citigroup, analyst Valentin Marinov said the fall of the euro "signals that investors remain more focused on potential contagion to other eurozone countries than they do the situation in Ireland."

"A failure from the euro to rally on this development (the Irish rescue) suggests investors do not believe the package goes far to averting strains in countries such as Portugal and Spain."

Questions about public finances in France, generally seen as one of the healthier eurozone countries despite a burgeoning public deficit, have also surfaced, prompting vigorous assertions from Paris authorities that such concerns are unfounded.

The government's chief spokesman on Tuesday said the country foresaw "no risk" that its top AAA credit rating will be downgraded.

© 2010 AFP

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