Euro crisis goes global as leaders fail to stop the rot

• G7 demands action from Europe after markets plunge
• Fears that banks' exposure to debt could wreck recovery

Phillip Inman and Ian Traynor in Brussels
guardian.co.uk, Friday 7 May 2010 19.44 BST


Germany's Angela Merkel and other European leaders is under increasing pressure over the Greek debt crisis going global as markets were in turmoil. Photograph: Tobias Schwarz /Reuters

The growing crisis in the eurozone threatened to undermine the global economic recovery as markets plunged across the world on fears that European leaders may not be able to contain the debt contagion spreading from Greece.

Stock markets in London, New York, and Shanghai dived following criticism that much delayed and half-hearted measures to rescue Greece were undermining confidence in wider efforts to kick start the world economy.

European shares finished the day at a six-month low while the Dow was down around 1% at 10,424. In Asia, the Shanghai stock market fell to an eight-month low of 2688, down 6.8% on the previous day.

An emergency summit of the 16 leaders of the countries using the single currency was held in Brussels , with Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France demanding tougher and quicker regulation of the financial markets in what looked like a doomed attempt to contain contagion from the Greek drama.

One factor being discussed last night was to persuade the ECB to launch a new quantitative easing policy – entailing huge loans to distressed governments in the form of buying up their bonds. This is supported by the European Commission, Spain, Portugal, Italy and France, but is certain to run into German opposition.

With the pace of developments outstripping the ability of political leaders to respond, what was initially called as a summit to bless a €110bn (£95bn) rescue package for Greece turned into a frantic exercise in global crisis management.

Alarm bells were ringing in major capitals across the world where leaders voiced their exasperation with European attempts to contain the fallout from Greece.

In what may have been Alistair Darling's last part in trying to manage international financial turbulence, the chancellor took part in a phone conference of G7 finance ministers discussing the implications for the international bond markets of the Greek debt debacle.

Australia's prime minister, Kevin Rudd, was scathing about the EU package for Greece over three years agreed last weekend by 15 eurozone countries and the International Monetary Fund: "Markets have judged those arrangements to be inadequate," he said .

"This is a global issue," Japan's deputy finance minister, Rintaro Tamaki, told Bloomberg news agency. "All the financial markets are now in turmoil … The impact of the Greek crisis has gone beyond the euro area."

There were also mounting concerns that the exposure of banks to sovereign debt throughout Europe risks destabilising a financial system that was bailed out by government across the world little more than a year ago.

In Germany, the key European player in the crisis, parliament agreed to the highly unpopular bailout, voting for more than €22bn in emergency loans to Athens.

While pleading for the funds, Merkel has rounded furiously on the markets. After stating earlier this week that "politics have to reassert primacy over the financial markets", she said that the "speculators are our opponents" and described the banks as "perfidious".

Describing politicians as being in battle with the markets, she added: "Like all my other colleagues, I want to win this fight."

But borrowing costs for Spain and Portugal rose to their highest levels, a day after the euro sank to its lowest against the dollar for more than a year.

Merkel and Sarkozy, while frequently at odds, demanded that tonight's summit consider moves to impose tougher penalties on eurozone countries breaking the fiscal rules and for greater peer review of each other's budgets. They reserved their strongest criticism for the markets and the credit rating agencies which they blamed for making a bad situation worse.

"Market reactions during the last few days have amplified the crisis and provoked very large swings in the yields of some euro-area member states' sovereign bonds not aligned with the development of fundamentals," they said. "In the light of last week's events, a review should explicitly refer to the rating process for sovereign debts, to communication methods and the publication of rating changes, taking into account the possible role of credit rating agencies in amplifying the crisis and their impact on financial stability. Potential actions should include stricter standards under European law."

Some efforts of European leadersto contain the crisis have been undermined by objections from taxpayers and ties to Greece through the banking system. Five German academics today vowed to pursue court action against the Merkel government for wasting taxpayers' funds in the bailout. They are believed to represent a swath of German public opinion already angry at the billions of euros spent bailing out local banks.

However, French, German and Swiss banks are the largest holders of Greek and Spanish debt. If Greek bonds lose value, or the bailout fails and Greece is ejected from the eurozone, the French and German governments would again be forced to bail out their banks with taxpayer funds.

This threat to European banks has already prompted anxiety about their ability to repay loans. Most financial institutions, including UK banks, are still recapitalising their balance sheets and building up their cash deposits after the collapse of Lehman Brothers investment bank in September 2008 brought the financial system to its knees. Many of their deposits are held in government bonds. If the ratings on government debt continues to fall it not only affects the government's themselves but also the banks holding the debt.

Capital Economics said the situation was delicately balanced and could become "devastating": "So far, the crisis in Greece has not caused the money markets to freeze up. But if this situation were to change, the impact on risky asset prices could be devastating and derail the fragile global economic recovery. Policymakers know this only too well after the events of September 2008."

Cracks have already begun to appear in the system. The cost of insuring against a default by banks in the euro-zone has risen sharply in recent days.

Europe's sovereign debt crisis is making it harder for European banks to get their hands on dollars and may require their central banks to step in with short-term liquidity to keep up the flow of money through Europe's economy.

Market commentators have asked if the Greek government is strong enough to push through austerity measures demanded by the IMF and eurozone countries, hinting that ejection from the euro area remains a possible outcome.

Riots and strikes in Greece could be repeated in other countries which have yet to adopt their own austerity packages.

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