Heavy lifting yet required to address solvency and bank issues By William L. Watts, MarketWatch LONDON (MarketWatch) — The hard work still lies ahead, but peripheral euro-zone bond and equity markets on Monday were quick to cheer an unexpectedly early agreement to boost the lending capacity of the region’s bailout fund and to lower the interest rate on Greece’s rescue loans. Government-bond yields fell across the periphery of the euro zone, with the premium demanded by investors to hold Portuguese, Greek and Irish debt falling. Peripheral equity markets bucked weakness elsewhere to gain ground. The cost of protecting peripheral euro-zone debt against default fell after a sharp run-up last week. Data-provider CMA said the spread on five-year Portuguese credit-default swaps, or CDSs, narrowed to around 479 basis points from nearly 511 basis points on Friday. That means it would now cost $479,000 annually to insure $10 million of Portuguese debt against default for five years. The Spanish CDS spread narrowed by around 20 basis points to 236, while the Greek CDS spread narrowed to around 1,014 basis points from nearly 1,087.A basis point is 0.01 percentage point. The measures “may buy enough time for some of the peripheral countries to improve their fiscal situations, although the solvency of Greece and Ireland in particular will still remain an issue,” said Gary Jenkins, head of fixed-income research at Evolution Securities, in a note to clients. “But it does not change the overall picture and leaves the euro-area sovereigns open to further volatility should there be any adverse shock to the system,” he said. The euro (EURUSD 1.3957, -0.0003, -0.0215%) was little changed, trading at $1.3950 versus the dollar, a gain of 0.1%. Peripheral euro-zone equity markets bucked a losing trend seen elsewhere in Europe, with Spain’s IBEX rising 2%, Portugal’s PSI index rising 1% and Athens’s ASE index jumping more than 4%. In negotiations that concluded in the early hours of Saturday morning, leaders of the 17 euro-zone nations agreed to boost their lending capacity to a full 500 billion euros ($694.9 billion) from slightly more than €300 billion. They also agreed to ensure that the permanent bailout mechanism to be put in place in 2013 will also offer half a trillion euros in capacity. They also agreed to allow the bailout funds to be used to buy bonds from governments directly, but they rejected calls to purchase bonds on the secondary market from investors. The rate charged Greece on loans under the €80 billion rescue package it was granted last spring was also cut by 1 percentage point from a rate of nearly 6%. Ireland received no such break, however, as new Irish Prime Minister Enda Kenny resisted calls for the country to boost its corporate tax rate. Leaders also reached agreement on a German-led Pact for the Euro, a watered-down version of the controversial competitiveness pact designed to increase coordination of economic policies and boost budget oversight across the euro zone. The talks were a precursor to a summit of European Union leaders on March 24 and 25. Bickering among European leaders in the run-up to the gathering had left economists with few hopes for progress. Encouragement, Caution Analyst said the scope of the weekend agreement was encouraging, but they warned that substantial work must yet be done to address the root causes of the region’s debt crisis as well as concerns about solvency. The cut in Greece’s interest rate, for example, won’t be enough to dispel fears that Athens will eventually be forced to restructure government debt, economists said. “What is truly needed to turn things around is peripheral countries’ capability to start delivering a large primary [budget] surplus on a sustainable basis, coupled with the clear commitment of national governments to recapitalize their own banking sector,” said Marco Valli, chief euro-zone economist at UniCredit Bank in Milan. Primary budget surpluses won’t be seen in the short term, while bank recapitalization will depend on the delivery of credible stress tests and the ability to provide funds that can be used to shore up the financial sector. “In this respect, allowing the EFSF to recapitalize banks would have been a smart idea,” Valli said in a note to investors. “Even after this weekend’s news, we remain convinced that the risk of sovereign-debt restructuring will not decline in any meaningful way in the foreseeable future.” But Howard Archer, chief European economist at IHS Global Insight, argued that the agreement was an important step in dealing with the debt crisis. He did say that any respite will prove only temporary if countries don’t take needed action on public finances, banks and competitiveness.

Source