FRANKFURT, Germany (AP) — Europe’s debt problem solved? Not yet.
An agreement by most European Union members to crack down on overspending will help ensure the current debt crisis isn’t repeated, and might help heavily indebted governments to slowly regain market confidence.
But the fiscal austerity treaty does little to immediately lower the high borrowing costs threatening countries such as Italy and Spain. And what financial markets really want to know, says Stephen Lewis of Monument Securities in London, is “how eurozone governments and banks will finance themselves over the next three months.”
Countries will reduce their deficits to try and convince markets they can pay back their loans. The European Central Bank will help put downward pressure on government borrowing costs by making limited purchases of their bonds. But without a promise of more aggressive action by the ECB, or another institution, to take the threat of government defaults off the table, bond markets will remain panicky.
ECB President Mario Draghi praised the agreement made Friday in Brussels. But he appears to have rejected for now calls for the bank to make large-scale purchases of European bonds, something financial markets are hoping for.
The yield on 10-year Italian bonds, which rises as markets grow more skeptical about the country’s ability to pay its debts, remained at around 6.55 percent on Friday. That’s not far below the level that forced the bailouts of Greece, Ireland and Portugal.
Italy alone has (euro) 1.9 trillion ($2.5 trillion) in debt outstanding, and has (euro) 300 billion in debt to roll over next year. To put that into perspective, Europe’s temporary bailout fund is equipped with (euro) 440 billion, part of which is already committed to Greece, Ireland and Portugal. European countries have agreed to loan (euro) 200 billion to the International Monetary Fund to bolster its ability to help save the euro. Still, more financial firepower is needed to calm bond investors, analysts say.
The debt crisis threatens not only governments, but the banks that lend to them. European commercial banks are holding Italian and Spanish bonds that have plunged in value because of fears of government defaults. As a result, banks have become too nervous to lend to each other. That credit squeeze is being felt globally.
“On paper, (Friday’s) measures should help to reduce the risks that another debt crisis such as that seen over the last two years is ever allowed to develop,” said Jonathan Loynes at Capital Economics.
“What the summit did not produce, however, was the action that the markets and many commentators had pinned their hopes on as the main solution to the current crisis — namely, much bigger bond purchases by the European Central Bank.”
All countries that commit to the new EU treaty cannot allow their annual deficits to exceed 0.5 percent of economic output in normal times. That cap can be broken — and rises to 3 percent — if there’s a recession or other exceptional circumstances. And there will be automatic penalties for countries whose deficits exceed 3 percent of GDP.
So pressure is rising on governments to keep cut spending and raise taxes. But such austerity weighs on economic growth, complicating the continent’s effort to dig out from under its debt burden in the long run.
There are still “huge problems to be overcome,” said Jane Foley, an analyst at Rabobank who believes European governments will struggle to borrow at reasonable rates at least through next year.
“The crisis rumbles on,” she said.
Leading up to Friday’s summit, expectations had been rising that the ECB was ready to make much larger purchases of government bonds so long as governments agreed to stricter budget discipline. But afterward, hopes were fading somewhat.
Economists at RBC Capital Markets wrote that Draghi “made it clear that the ECB was not about to change tack on the bond purchase front” and deliver unlimited, open-ended purchases. So far the ECB has spent about (euro) 207 billion, only a small fraction of outstanding debt from Europe’s troubled countries.
Analysts say it’s possible the ECB could increase the size of its weekly purchases to a level just high enough to keep Europe from a financial meltdown. Last week, the bank bought (euro) 3.66 billion of government debt, down from (euro) 8.58 billion the week before.