Spanish, Italian markets slammed by investor fears

By Ciaran Giles

Associated Press

Published: Tuesday, Aug. 2 2011 6:45 a.m. MDT

FILE - In this June 29, 2011 file photo, Spain's Prime Minister Jose Luis Rodriguez Zapatero leaves after the annual debate on the state of the nation in the Spanish Parliament, in Madrid. Zapatero's office announced Tuesday Aug. 2, 2011 that the premier had postponed the start Tuesday of his near three-week summer vacation to monitor the crisis. The European Commission said is convinced that "Spanish authorities will take all steps that are necessary" to get its economy back on track, said Chantal Hughes, a spokeswoman for the EU's executive.

Daniel Ochoa de Olza, File, Associated Press

MADRID — Investors dealt Italy and Spain a battering Tuesday as the yields on their bonds struck euro-era highs amid mounting fears that an economic slowdown will hurt their chances of dodging Europe's spreading debt crisis.

The yield for the Spanish 10-year bond rose to 6.45 percent, the highest since the euro was created, before easing back slightly to 6.39 percent by midday. The rate is near the levels seen in Greece, Ireland and Portugal before those countries were forced to ask for rescue loans.

Italy's equivalent yield jumped to 6.18 percent, above where it was before July 21, when the EU announced its latest debt crisis plan, including and a second Greek bailout, to calm and contain market jitters.

The increased market pressure bodes ill for Italy and Spain, the eurozone's third- and fourth-largest economies, who are both too expensive to rescue for Europe's bailout fund.

The turmoil is due to a toxic mix of market concerns about growth, not only in Europe but also the U.S., and the possibility that the debt crisis will continue spreading.

Over the past two weeks, markets have been roiled by worries that the U.S. economy may be sliding back towards recession and have its credit rating cut. In times of trouble, investors' knee-jerk reaction is to sell what they perceive as high-risk assets and buy into safer ones.

That was evident by the fall in the yield for German bonds, which investors bought up. The yield falls as the price of a bond price increases.

The rising borrowing rates sent shockwaves rippling through the two nations' political leadership, with Italian Finance Minister Giulio Tremonti calling an emergency meeting to analyze the situation.

And Spanish Prime Minister Jose Luis Rodriguez Zapatero postponed Tuesday the start of his near three-week summer vacation to keep abreast of economic developments.

European officials sought to downplay the danger of Spain and Italy edging closer toward needing a bailout, but the European Commission was monitoring the situation closely.

"We are very confident in both the Spanish and Italian authorities' determination to get their economies back on track," said Chantal Hughes, a spokeswoman for the EU's executive.

She said the Commission was closely monitoring developments on the markets and that, in its view, "there is no factual evidence (about the two countries' economies) that has changed in the last few days."

"The question of a rescue plan (for Spain) is not on the table, it hasn't been discussed," Hughes said.

Eurozone leaders agreed July 21 on a second, €109 billion ($157 billion) bailout for Greece and overhauled their rescue fund in hopes of keeping market turmoil from spreading to Spain and Italy, which are regarded as too big to bail out.

But the Greek deal gave only a temporary lift to Spanish and Italian bonds.

Just days after the deal, global markets were rocked by the possibility that the U.S. may default on its debt by not raising its borrowing ceiling. It managed to clinch a deal just in time, but investor sentiment was shaken. At the same time, U.S. indicators showed its economy was slowing sharply. The combination caused traders to move their cash into the safest investments — such as German bonds, Swiss accounts, gold.

In that context, confidence in the EU crisis plan's ability to protect Spain and Italy from the market turmoil dropped rapidly.

That is partly because the deal included asking bondholders to take losses on the value of their holdings by swapping them for longer-dated bonds with lower interest.

Losses for private investors — a first in the 21-month debt crisis — has underlined the risks to banks, insurance companies and others who hold eurozone debt.

Elevated yields show the additional interest investors demand to hold the country's debt, and underline how their financing costs could rise when they need to tap bond markets again. As fears of default increase, interest rates rise and make paying debt even harder in a vicious circle.

Trading on Madrid's stock exchange was also negative, down 0.3 percent after losing 3.4 percent Monday. Milan's Stock Exchange's benchmark FTSE MIB was down 1 percent.

Spain is struggling to recover from nearly two years of recession triggered in large part by the collapse of an overheated real estate sector. Burdened by a swollen deficit, the country's jobless rate stands at a eurozone high of nearly 21 percent.

Italy has debt of 120 percent of economic output, but had been viewed for months with calm by bond markets. The country has low levels of private debt and has not had the real estate boom and bust that caused trouble for the United States, Spain, and Ireland.

But it suffers from chronically weak growth, and doubts about the government's willingness to make tough reforms to increase the productivity of the economy.

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David McHugh in Frankfurt, Colleen Barry in Milan and Gabriele Steinhauser in Brussels contributed to this report.

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