Bond market gives eurozone brief respite

By David Mchugh

Associated Press

Published: Wednesday, Jan. 4 2012 9:46 a.m. MST

Spanish broker Cristina Garcia talks with a colleague in a trading room of a Portuguese bank, Wednesday, Jan. 4, 2012, in Lisbon. Portugal has paid a markedly lower interest rate to borrow amidst a government austerity program aimed at winning back market confidence. Portugal's government debt agency said it sold 3-month Treasury bills following a similar auction last month.

Francisco Seco, Associated Press

LISBON, Portugal — Europe won some further modest respite from its debt crisis Wednesday as Germany and Portugal became the latest countries to borrow with relative ease ahead of a hazard-filled few weeks for the 17-nation eurozone.

But news that a major Italian bank had to offer an unexpectedly large discount to raise new capital and strengthen its finances was a reminder of how the crisis is weighing on banks, as well as governments.

Germany, the biggest contributor in Europe's bailouts, managed to sell €4.06 billion ($5.3 billion) in its benchmark ten-year bonds Wednesday at an average yield of 1.93 percent, down on the previous 1.98 percent it had to pay. But demand barely covered the bonds on offer. And Portugal, which was bailed out last April after being locked out of international markets, paid a markedly lower interest rate to borrow €1 billion ($1.3 billion) in three-month treasury bills.

Though Germany and Portugal enjoyed modest successes, Italian bank UniCredit saw its share price tumble by over 10 percent on the news it was selling new shares at a large 69 percent discount to Tuesday's closing price. UniCredit is trying to raise €7.5 billion ($9.8 billion) to meet new European requirements for banks to thicken their financial cushions against possible losses.

Banks are an integral part of the debt crisis because they hold government bonds. A default or steep fall in the value of bonds issued by an indebted government could inflict heavy losses on banks and choke off credit to the economy. That's why the regulatory authorities want Europe's banks to raise their buffers by €115 billion ($150 billion) over the next few months.

The German and Portuguese auctions come ahead of severe tests for eurozone leaders as they try to navigate their way out of their crisis over too much debt in some countries.

Eurozone governments are struggling to convince financial markets that indebted governments will not default and should be able to borrow at affordable rates to repay debts as they come due. Greece, Ireland and Portugal have needed bailouts, while much larger Italy and Spain have seen their borrowing costs rise ominously.

Italy, the recent focus of the crisis, must borrow to cover €53 billion ($69 billion) in expiring debt in the first quarter alone in a series of debt auctions beginning Jan. 13. They will test whether the government of new Prime Minister Mario Monti is making progress in regaining market confidence through budget cuts and efforts to improve weak economic growth.

Further trouble could come from a slowing eurozone economy that may already have shrunk in the fourth quarter.

Additionally, Greece must also win approval of a second, €130 billion ($169 billion) bailout, without which it can't pay its debts. As part of that, the government must strike a deal with creditors for a 50 percent reduction in their holdings of Greek debt to try to put the country back on its feet.

Fellow bailout recipient Portugal looks like it's in better shape at the moment. The rate it had to pay at its auction earlier fell to an eight-month low of 4.346 percent. Though Portugal cannot tap long-term bond markets at a reasonable price, it has sought to maintain a market presence by issuing shorter-term debt.

Analysts said the improvement may represent a sign that Portugal is regaining the markets' confidence as it carries out spending cuts and revenue increases in return for its €78 billion ($102 billion) bailout.

"There's been an improvement in the risk perception of Portuguese debt, which has driven rates down" said Filipe Silva, debt manager at Portuguese financial group Banco Carregosa. "Now we just need to see whether it holds."

Germany's auction was better than one in November which raised fears that Europe's debt crisis was spiraling out of control when the government sold only 65 percent of debt on offer.

Still, there was some concern voiced over the amount of German bunds investors actually wanted Wednesday.

Bids for €5.14 billion ($6.7 billion) worth of bonds exceeded the full amount on offer of €5 billion ($6.5 billion), but only barely, counting €943 million ($1.23 billion) the government kept back for secondary market operations.

"Yes, it was covered, so that's a relief," said Marc Ostwald, a markets strategist at Monument Securities. "On the other hand, the coverage was poor."

Germany can borrow cheaply and for longer because its finances are among the strongest in the eurozone but concerns about the costs of bailing out other countries have raised questions about its finances too.

Wednesday's auction results follow a recent trend somewhat. On Tuesday, the Netherlands saw its borrowing rates fell to near zero percent in a pair of short-term auctions, in a sign that investors are searching out what they consider to be Europe's safer assets.

Italy also sold large chunks of debt last week and analysts say the run of smooth auctions may be largely due to a massive €489 billion ($636 billion) infusion of cheap, 3-year credit to eurozone banks by the European Central Bank. Some of that cheap money may be being used by some banks to buy higher-yielding short-term debt, though Italy's longer-term borrowing rate in the markets remain at dangerously elevated levels near 7 percent.

McHugh contributed from Frankfurt, Germany. Frances D'Emilio in Rome contributed too.

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