Wednesday, 15 June 2011

Greece: the Crisis Reaches New Highs

Euro area Finance Ministers so far have failed to find enough common ground on the next steps to address the Greek crisis, which continues to deepen inexorably. Credit rating agencies are mounting the pressure on Greek banks and financial institutions which are deemed to have material exposures towards Greece. All this is amplifying uncertainty and -- by reflex -- market volatility. Against this backdrop, Greek two-year yields reached their EMU era peak of 28%, and the euro hit a one-month low.

Sovereign bond yields at the periphery, Italy included, are all trading at distressed levels, close to one-year highs, as fears of contagion escalate. This is not a good sign.

In principle, next week’s Eurogroup and Ecofin meetings could mark some progress (June 20-21) and help to mitigate market distress, but there are two major policy complications.

Firstly, there is still a divide between the German inclination towards private sector burden-sharing and the Franco-ECB objection to anything that carries an‚element of compulsion?. A compromise will need to be forged to avoid a policy deadlock.

Second, even assuming that this major hurdle is cleared, an even bigger one is shaping up. On Wednesday, Prime Minister Papandreou offered to resign on the condition that all opposition parties agree to the additional austerity measures required under the EU/IMF programme.

This looks like a last ditch effort from Papandreou to save the situation as his Parliamentary majority is eroded, and the opposition threatens to renege on the conditions adhered to when the IMF Stand-By Arrangement was originally signed back in May 2010. Meeting these programme requirements is a binding condition for a continuation of the EU/IMF quarterly disbursements, which are necessary to plug Greece’s funding gap.

Greece’s situation, and the euro area’s sovereign crisis, have reached a new level of uncertainty.

- SocGen