Europe's debt markets are flashing danger signals after spreads on Iberian debt reached the highest level

Merkel plea to save Europe as contagion hits Iberia

Europe's debt markets are flashing danger signals after spreads on Iberian debt reached the highest level since the launch of the euro and investors rushed for safety into German notes, prompting warnings from German Chancellor Angela Merkel that the European Project itself is at risk.

By Ambrose Evans-Pritchard, International Business Editor
Published: 9:53PM BST 05 May 2010
Comments 139

"Contagion pressures continue to rage unabated," said Marco Annunziata, Europe economist at UniCredit. "The flames have rushed through the firewall of the IMF/EU programme for Greece and now threaten other peripheral countries."

"While the sell-off on sovereign bond markets so far remains discriminating, the risk that it might suddenly mutate into irrational panic can no longer be ignored. Eurozone policymakers need to take further steps quickly," he said.

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Mrs Merkel made a moving plea to the Bundestag to support the €110bn (£93bn) rescue for Greece. "Nothing less than the future of Europe is at stake. The happy tale of German history since World War Two and our emergence as a free, united, and strong country cannot be separated from the European Union. We owe decades of peace and prosperity to the understanding of our neighbours," she said.

"Europe today is looking to Germany. As the strongest economy in Europe, Germany has a special responsibility and it takes this responsibility to heart.

"Immediate help is needed to ensure the financial stability of the eurozone. This must be done to avoid a chain-reaction to the European and international financial system, and contagion to other eurozone states. There is no alternative."

Belated support from Berlin has failed to stop the crisis escalating. Spreads on Portuguese 10-year bonds soared to a post-EMU record of 290 basis points above Bunds; Spanish spreads rose to 131. Bank shares in Madrid slid again, with falls of 4.9pc for Banco Popular, 3.6pc for BBVA, and 2.5pc for Santander

Bundesbank chief Axel Weber said there was a "grave threat of contagion", echoing the formula now being used by German officials to justify the rescue. Berlin hopes the wording will head off a legal challenge at the constititional court.

Flight to safety has driven the yield on two-year German debt to an all-time low of 0.59pc. Andrew Guy, managing director of ADG, said the rate had dropped below the three-month euribor rate in a sign of stress. "The last time this happened was August 2007 at the beginning of the financial crisis," he said.

One credit expert said events risk mutating into a full-blown `Lehman disaster' unless the European Central Bank opts for massive bond purchases.

Spreads on Greek debt exploded again as tens of thousands of demonstrators took to the streets and three people died in an attack on the Marfin Bank in Athens. "A demonstration is one thing, murder is quite another," said premier George Papandreou.

The key cities were paralized by a general strike. "The country cannot surrender without a fight," said Yiannis Panagopoulos, head of the GSEE private sector union. Unity fractured further after the New Democracy oppostion party broke ranks and votee against the austerity measures.

Markets view the EU-IMF package for Greece as a politically-shaped response that cannot work because it shuts off the twin cures of debt restructuring and devaluation, leaving the burden of adjustment on the Greek people. If Greeks come to view the plan as a rescue for foreign banks and funds – as many already do – there is no chance of carrying the nation through five years of harsh austerity

Dominique Strauss-Khan, the head of the IMF, admitted that the plan was flawed, telling Le Parisien that the EU was charging excessive interest rates at 5pc. He said Europe must "urgently" create some form of fiscal union to shore up EMU, describing the euro as a half-finsihed job.

Many investors view the EU-IMF plan as a "quick fix" that puts off the day of reckoning. Bill Gross, head of the US bond fund Pimco, said a "restructuring event" was inevitable in the end.

Julian Callow from Barclays Capital said Greece must reduce its primary budget balance by 14.5pc of GDP over five years, a task that is "unprecedented in European experience". The country will end up with a debt of 151pc, even it if complies. Since tax rises and wage cuts entail a protracted slump that crushes tax revenue, Greece may find itself in a deflationary spiral that feeds on itself.

There is mounting concern that the IMF is squandering its fire-power on a dubious plan, rather than ring-fencing Greece with a controlled default and reserving its clout to defend a more credible line on Iberian debt – which is what really matters for Europe's banks. By failing to fix achievable priorities, the IMF risks a drift into deeper crisis. ... beria.html