Euro zone periphery hammered as default fears rise

LISBON/DUBLIN (Reuters) - The euro zone’s debt crisis deepened on Tuesday as investors pushed the spreads on Spanish, Italian and Belgian bonds to euro lifetime highs and Portugal warned of “intolerable risks” facing its banks.

The euro dipped below $1.30 for the first time since mid-September, immune to new attempts by European policymakers to calm markets hell-bent on testing the EU’s determination to shield its financially weak members and increasingly nervous about the possibility of future euro zone defaults.

Two days after the bloc approved an 85 billion euro ($111.7 billion) emergency aid package for Ireland, worries about contagion to Portugal and Spain persisted and the borrowing costs of large countries like Italy and France shot higher.

Markets are already discounting an eventual rescue of Portugal although the government in Lisbon denies, as Irish leaders initially did, that the country needs outside aid.

While a Portuguese rescue would be manageable, assistance for its larger neighbour Spain would sorely test EU resources, raise deeper questions about the integrity of the 12-year old currency area, and possibly spread contagion beyond Europe.

Italy, the euro zone’s third largest economy, is now being referred to as “too big to fail” and “too big to bail”.

Citigroup Chief Economist Willem Buiter described the turbulence hitting the euro zone as an “opening act” and predicted that sovereign default fears could soon extend to Japan and the United States.

“There is no such thing as an absolutely safe sovereign,” he wrote in a research note.

Tomasso Padoa-Schioppa, a former Italian finance minister and ECB member who is advising Greece’s government, admitted that markets were “very nervous”, describing worries about Spain and other large euro members as “excessive”.

The euro dipped below $1.30 and has now shed more than 7 percent of its value against the dollar since early November. The yield spreads of 10-year Spanish , Italian and Belgian bonds over German benchmarks spiked to their highest levels since the birth of the euro in January 1999.

The iTraxx SovX index of western European credit default swap prices rose to an all-time high above 200 basis points as the cost of protecting against a euro zone sovereign debt default surged.

“It’s very worrying because Spain is almost too big to be bailed out ... whereas Italy is too big to be bailed out,” said Everett Brown, European bond strategist at IDEAglobal.

Jitters also hit European banking shares, which were led lower by French banks BNP Paribas, Societe Generale and Credit Agricole on market rumours Standard & Poor’s might cut France’s outlook -- talk swiftly denied by the government in Paris.

“There is no reason for concern, no risk,” said Francois Baroin, budget minister and government spokesman.

Deepening the sense of gloom, Portugal’s central bank warned that its country’s banks faced an “intolerable risk” if the government in Lisbon failed to consolidate public finances.

Although the minority Socialist government in Portugal approved an austerity budget for 2011 last week, it is struggling to meet its targets for deficit reduction, with the core state sector shortfall widening 1.8 percent in the first 10 months of this year.

The worry is that troubles in Portugal could spread quickly to Spain because of their close economic ties.

Data released on Tuesday underscored economic divergences within the euro zone, which pose an increasing challenge to the European Central Bank and its one-size-fits-all monetary policy.

German unemployment fell in November for a 16th straight month while Italy’s unemployment rate jumped to 8.6 percent in October from 8.3 percent the month before.

Greek retail sales plunged 9.9 percent year-on-year in September under the weight of crushing austerity measures agreed in exchange for its 110 billion euro bailout.

Ireland faces a daunting task meeting the terms of its own bailout and cleaning up its battered banks. Irish bank debt spreads continued to widen on Tuesday despite the rescue.

In addition to Ireland’s bailout, European leaders approved on Sunday the outlines of a long-term European Stability Mechanism (ESM), based on a Franco-German proposal, that will create a permanent bailout facility and make the private sector gradually share the burden of any future default.

Although private bondholders will not be asked to share the cost of debt restructurings until after mid-2013 and then only on a case-by-case basis, the mechanism has raised fears of future defaults and the likelihood of so-called “haircuts” down the road.

Eurointelligence, an online commentary service, said markets were growing increasingly concerned about the solvency of euro zone peripheral states after focusing mainly on their short-term liquidity problems in past weeks.

“We at Eurointelligence consider a default of Greece, Ireland and Portugal a done deal,” they wrote on Tuesday. “The question is only now whether Spain can scrape through.”