Markets bounce on euro deal despite long-term concerns

By DOMINIC JEFF
Published on 30/06/2012 00:00

Stock markets gave an enthusiastic cheer to an 11th-hour deal among European leaders aimed at capping borrowing costs in Italy and Spain while re-capitalising the region’s banks.

Leading share indices in France and Germany closed more than 4 per cent higher yesterday after politicians hammered out a convincing deal in a marathon, 14-hour overnight meeting.

Italian and Spanish shares enjoyed even stronger gains as the agreement that EU bail-out funds could be used to stabilise bond markets without forcing countries that accept the cash to comply with tough budget rules was seen as a victory for indebted southern nations.

Several eurozone economies are struggling to implement austerity measures in the face of high unemployment and recession.

But the London market was more cautious. Analysts welcomed the fact that banks will from now on be bailed out directly with European funds but pointed out that the devil would be in the detail. The agreement remains in principle only.

The benchmark FTSE 100 Index added 1.4 per cent, or 78.1 points, to close at 5,571.15. Gains came despite news that the dominant service sector stagnated in April and was therefore unlikely to help the UK economy out of recession in the second quarter.

Michael Hewson, senior market analyst at CMC Markets, said the EU agreement was “not a game-changer by any stretch of the imagination”.

“While these steps are welcome in breaking the link between the banks and the sovereign, it does nothing to address the fundamental insolvency of a lot of the European banking system,” Hewson noted.

Previous stock market rallies on the back of apparent action by the EU have faded quickly, but yesterday’s recovery appeared to have more legs as it built momentum despite perceived attempts by German chancellor Angela Merkel to climb down from her U-turn of the night before.

But Hewson warned that the markets would lose their new-found enthusiasm if banking channels were not “unclogged” to improve Europe’s bleak growth outlook. He also questioned whether there is enough money in the planned bail-out fund to do the job.

Spanish and Italian borrowing costs eased a little following the deal, but Spain’s benchmark bond yields remained at about 6.5 per cent – making servicing its large debts painfully expensive.

With Germany holding out in its opposition to jointly guaranteed eurobonds, lenders are concerned by the prospect of default and are still demanding a “risk premium” for lending to peripheral countries.

Simon Denham, chief executive of Capital Spreads, said the cost of borrowing for the most troubled nations must fall below 4 per cent to afford room for stimulus packages. Without these the cost of sustaining the burden of debt will wipe out any impact that new spending would achieve, he argued.

“On current deficit levels Spain can no more afford 6.5 per cent in the long run than it could 10 per cent or 15 per cent,” he said.

“Oddly enough the powers that be might not be too unhappy about a general default of sovereign debt in the ‘garlic belt’ so long as the banking system remains intact.

“The markets are not sure about the intentions as can be seen from the yields in Spanish debt.”

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