Concerns intensified about the health of peripheral eurozone countries on Thursday following weaker than expected growth from Greece and a near-doubling in interest rates paid by Ireland compared with three weeks ago.
German benchmark market interest rates fell to record lows as investors fled to safe haven assets, in a week that has seen the spreads between Bunds and Greek, Portuguese, Irish, Italian and Spanish debt rise sharply.
“It is an interesting little warning sign this week. The problems have not gone away, the cracks have just been papered over,” said Gary Jenkins, head of fixed income at Evolution Securities.
Greece sank deeper into recession in the second quarter, according to provisional data released on Thursday. The Greek statistics service estimated the economy shrank 3.5 per cent in the three months to the end of June compared with the same period last year and 1.5 per cent compared with the first three months of this year.
“The second half of 2010 will be difficult ... There’s been a very steep decline in construction and the fourth quarter won’t be supported by tourism revenues,” said Platon Monokroussos, a senior economist at EFG Eurobank.
Problems in Ireland have also come into focus with fresh concerns about its banking sector and market rumours of the European Central Bank intervening to buy Irish bonds. The ECB declined to comment.
Ireland, which has been held up as a model performer for its deep early budget cuts, on Thursday sold €500m of six-month bills at an average yield of 2.458 per cent, against one of 1.367 per cent on July 22. It also sold €500m of nine-month bills.
The yield on Irish 10-year bonds stabilised but the spread over German Bunds has widened by 51 basis points since Friday and came close to a record high earlier this week.
“Ireland has done almost all it can and it still is vulnerable. It is quite a worrying prospect long term for the peripherals,” said Jim Reid, a bond strategist at Deutsche Bank.
The general move in the market away from riskier assets in the aftermath of weak economic data in the US and China has also hurt peripheral eurozone countries’ bonds and caused the relative optimism that followed the bank stress tests in Europe in July to evaporate.
The so-called Euribor-Eonia spread, a common measure of banking sector risk in Europe, climbed to its highest level since September yesterday while the cost of insuring against default by European banks on their debt also rose. Many investors are bracing themselves for more turmoil in the eurozone in the coming months.
“In the next 18 months we are expecting a further escalation of the crisis because we continue to see record issuance from peripheral countries into a shrunken investor pool. It is unclear whether we are at that point yet,” said Justin Knight, European bond strategist at UBS.
But other analysts argued that the safety net agreed by European leaders earlier this year should mitigate the danger of sudden trouble. “The danger of this turning into an imminent systemic meltdown are not there as we have the backstop stability program. But it is able to cause wobbles and mass volatility,” said Mr Reid.
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