Greek tragedy will continue despite bailout and bond issue

RIDING the wave of positive sentiment following the announcement of the EU’s support mechanism, the Greek Debt Management Agency yesterday sold €5bn of seven-year government bonds. As predicted, the response was poor and the yield very high, raising the chances that Greece will have to ask for help and Germany – despite its recent protests – is still expected be the biggest contributor. The poor response has also increased the risk of contagion to Portugal. We will now see a real test for the new support mechanism, both for the Economic and Monetary Union (EMU) and the euro.

Eurozone countries will have to acknowledge that their fiscal Stability Pact is inadequate. The formation of “economic governance” to better police the fiscal management of member nations has already been flagged. For many years, the Eurozone successfully sidestepped the long-standing argument that monetary unions could be unsustainable without any fiscal union. Doubts as to the union’s integrity have recently been gaining more momentum, and not purely as a result of the problems in Greece. Germany is also being blamed as being partly responsible for adding to the pressures.

The background to all this is that last week the EU last week finally agreed that a Eurozone member country in serious fiscal difficulties will be able to receive bilateral assistance from its Eurozone partners, as well as draw support from the International Monetary Fund (IMF). Following weeks of discord, a show of unity on how to deal with fiscally errant members became politically important. In this sense the announcement of an agreement was an important step in the right direction. The proof of the pudding is in the eating, however.

Even after yesterday, Greece still has to sell a significant amount of debt in the open market this spring – a five-year €8.2bn bond is due to expire on 20 April and a 10-year €8.5bn issue will expire on 19 May, and it is estimated that the Greeks need to raise a further €10bn to roll over its debt. The EU will be hoping that Greece, never mind Portugal or Spain, will not have to tap its partners for a loan.

Greek bond spreads tightened slightly in response to news of EU support but widened again at the news of an imminent issue. Yesterday’s bond sale itself pushed them even wider. The government needs to rein in the cost of borrowing if it is to have any chance of fulfilling its pledge to slash its budget deficit. Its financing problems will not be over if yields do not drop significantly and cheaper IMF financing could still be an attractive alternative for Greece later in the year.

By maintaining downward pressure on wage growth and conservative fiscal policies (which have contained domestic demand) Germany has built up trade surpluses which may destabilise the Eurozone. To match Germany’s competitiveness, a country could cut wages or devalue. Germany might also want to sour its competitiveness by revaluing, but clearly the options of revaluing and devaluing are not available to a Eurozone country, which turns the focus on wage costs.

The Irish government last year cut some civil servant wages by 20 per cent. This has boosted the country’s deficit-cutting credentials and reined in the cost of funding for the Irish debt office. Clearly slashing wages is not an option that would be swallowed everywhere. If toeing the EMU line on fiscal policy proves too tough, it is still possible that EMU may move forward with a different list of members. The euro is not out of the woods yet.

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THERE was no strong sell off in the pound after last week’s budget, but cable has been unable to push higher. The prospect of a hung parliament and the dark clouds looming over the economy give little cause for optimism. Unemployment is down and public borrowing is better than expected, but employment is at its lowest since November 1996 and the borrowing requirement is twice as high as this time last year. Today’s fourth-quarter GDP revision should confirm growth of 0.3 per cent, but this was supported by public spending. Short sterling vs the dollar may be a crowded trade, but the chances of a real recovery remain elusive.