EU Struggles to Convince on Greek Deal

Bloomberg

By Jeffrey Donovan - Jul 19, 2011 3:00 AM GMT+0300

European leaders are struggling to convince investors that they will agree on a second Greek bailout at a summit this week as record bond yields threaten to boost financing cost at sales of Spanish and Greek debt.

European Union government chiefs plan to meet for the second time in a month on July 21, aiming to break a deadlock over a new Greek rescue that has spooked investors. Spanish and Italian bonds yields surged yesterday, piling pressure on officials to end the turmoil. Spainand Greece sell as much as 5.75 billion euros ($8.1 billion) of bills today.

“As another D-day looms on Thursday, we have few soothing words, ”Suki Mann, senior credit strategist at Societe Generale SA in London, wrote in a note to investors. “Greece appears beyond repair, Italy is on the brink and the chances are that the euro might be no more very soon.”

EU President Herman van Rompuy asked leaders last week to meet in Brussels to discuss “the financial stability of the euro area as a whole and the future financing of the Greek program.” Yesterday, stocks declined around the world, the euro fell and the cost of insuring European sovereign debt rose to records amid concern the euro region isn’t any closer to solving the crisis a year after Greece’s initial rescue.

German Optimism

Chancellor Angela Merkel’s chief spokesman, Steffen Seibert, said Germany is confident the summit will produce an agreement to fund another bailout for Greece, which received a 110 billion-euro rescue in May of last year from the EU and the International Monetary Fund.

“We must master this challenge,” Seibert said yesterday in Berlin. Germany is “positive that we’ll have a package for Thursday that will secure Greece’s debt sustainability in the long term,” added Finance Ministry spokesman Martin Kotthaus.

With European debt markets in turmoil before the summit, both Greece and Spain will sell treasury bills today. Spain will auction 4.5 billion euros ($6.3 billion) in 1-year and 18-month bills. Greece will sell 1.25 billion euros of 3-month bills.

Yields on Spanish and Greek bonds hit euro-era records yesterday. Spanish 10-year yields rose 25 basis points to 6.32 percent, taking the spread over German bunds to 367 basis points. Greek two-year yields surged 291 basis points to 36 percent. Italy’s 10-year bond yield increased 21 basis points to 5.97 percent.

Disagreements

European leaders are at odds with one another and with the European Central Bank over demands by Germany and Finland that private investors bear some of the burden of a new Greek rescue. The summit also comes after European bank stress tests on July 15 failed to allay investor concern that lenders were prepared for a Greek default and that euro-area governments had the ability to bail them out.

“With this week’s summit, the results of the stress tests will only be secondary,” Carsten Brzeski, an economist at ING Group in Brussels, told Owen Thomas on Bloomberg Television’s “First Look” on July 18. “Just tough talk is not sufficient any more. We really need to see a breakthrough.”

A summit was originally mulled for last week before being postponed amid German fears it would backfire without a pact on private-sector involvement. Germany’s government says no extra aid is possible without bondholders staying exposed to Greek debt. By pushing for a voluntary rollover of Greek debt that risked pushing Greece into technical default, Germany also incurred the wrath of the ECB.

‘Highly Credible’

ECB President Jean-Claude Trichet told the Financial Times Deutschland in an interview published over the past weekend that Europe can surmount the crisis and the euro remains “a highly credible currency.” He reiterated that the ECB will not accept bonds from a nation that defaults as collateral.

French Finance Minister Francois Baroin said yesterday that he was “confident” an agreement on Greece would be reached at the summit that would satisfy the ECB.

“We are working hard for a solution that would allow avoiding a selective default or a credit event,” Baroin told journalists in Washington.

Among topics for the talks is a potential overhaul of the 440 billion-euro rescue fund to enable Greece to better pay its bills. Euro-area finance chiefs last week revived the idea of allow countries to use loans from the fund to repurchase and cancel their own debt in secondary markets.

Expanding Fund

The fund, known as the EFSF, would need to be increased to near 2 trillion euros and “and become a de facto common bond type instrument,” to solve the crisis, Royal Bank of Scotland economists including Jacques Cailloux said in a research note published on July 13.

The market rout may be convincing Germany that the ECB is right about avoiding a default event, said Marco Valli, chief euro-area economist at UniCredit SpA in Milan.

“We’re really running out of time” and Germany “will take a step back and accept that private-sector involvement will occur mostly via EFSF buybacks,” Valli added, referring to the region’s rescue fund, the European Financial Stability Facility.

To contact the reporter on this story: Jeffrey Donovan at jdonovan26@bloomberg.net