Friday, November 26, 2010

Eurozone Borrowing Costs Hit Record

Eurozone borrowing costs hit record

By David Oakley in London, Quentin Peel in Berlin and Nikki Tait in Brussels
Last updated: November 25 2010 19:47
Financial Times

The cost of borrowing for the eurozone’s peripheral economies rose to record highs on Thursday amid signs the debt crisis that forced Ireland into a multibillion-euro bail-out was spreading.

Irish, Portuguese and Spanish bond yields surged to their highest points since the launch of the euro, as traders said even some of the bigger eurozone countries could soon be affected. Matt King, global head of credit strategy at Citi, said the danger was the selling could develop a momentum of its own.

The moment you have even a flicker of a doubt about default risk, it becomes rational to reduce positions in a larger country like Spain purely on grounds of diversification,” he said.

Some traders warned that contagion could even spread to the core eurozone debt markets of France and the Netherlands.

Don Smith, economist at Icap, said: “Wildfire can be very difficult to put out. The contagion could eventually spread all the way to France. The markets are very nervous.”

Myles Clarke at RBS said: “Some people want to put on a just-in-case euro break-up trade and they’re looking for any way to do this. You can’t do trades in any size in the stressed peripherals like Ireland or Spain, so people are looking for what else might work.”

A senior trader at a US investment bank added: “I’m freaking out. The investors who were bottom-fishing last week are all selling this week.”

Irish 10-year bond yields rose above 9 per cent, Portuguese yields jumped further above 7 per cent – a level Lisbon says is not sustainable – while Spanish yields rose further above 5 per cent. The euro dipped towards two-month lows, falling for the fourth day in a row.

The renewed volatility came as Germany rejected any suggestion of an increase in the size of the €440bn ($588bn) European financial stability facility – the eurozone rescue fund established by European Union finance ministers in May to help debt-laden members of the common currency zone.

Media reports said the German government had been approached by the European Commission to double the size of the rescue fund, to ensure funds were available in the event of Spain and Portugal seeking assistance.

Elsewhere, EU officials said they wanted to include liquidity ratios in a fresh round of bank stress tests, which could get under way as early as the first quarter of next year.

The move follows criticism of the last stress test exercise, conducted by the Committee of European Banking Supervisors, which focused heavily on capital ratios. When the results were published in July, 84 of the 91 European banks scrutinised had passed.

Among banks that comfortably passed were Allied Irish Banks and Bank of Ireland. That, however, failed to insulate Ireland’s two biggest lenders from a commercial funding squeeze which, in turn, was the catalyst for the current Irish crisis.

The Irish markets were also undermined by LCH.Clearnet, one of Europe’s biggest clearing houses, again increasing charges for trading Irish bonds because of the jump in the country’s cost of borrowing. It is the third increase in as many weeks.

The clearing house increased the charges or margins from 30 per cent to 45 per cent above normal requirements to trade Irish bonds. This makes Ireland’s banks, which use sovereign bonds to raise money for funding, even more dependent on the European Central Bank.

There was also speculation that Portugal could be hit with extra charges for margin requirements because bond yields have risen close to levels that would trigger increases.

LCH.Clearnet is used by banks and financial institutions in so-called repurchase transactions, where bonds are exchanged for cash. It shares the burden in a potential bond default and allows banks to reduce their counterparty risk.

Additional reporting by Richard Milne

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