European leaders are poised to use two rescue funds to buy Spanish and Italian debts in a £600bn bail-out, as a Bank of England policy maker tells traders to prepare for a devastating market seizure like that seen as the collapse of Lehman Brothers.
Cheap and ready access to the liquid assets that oil the financial markets are under threat from both state-imposed capital controls and flagging confidence in the euro, said Robert Jenkins, a member of the Bank’s Financial Policy Committee.
Without easy access to liquidity, markets could seize in a re-run of the credit crunch after the collapse of Lehman Brothers, he warned.
The warning comes after it emerged last night that European leaders are poised to announce a £600bn deal to bail out Spain and Italy.
Two rescue funds are to be used to buy the debts of the troubled economies, the cost of which have reached record highs in recent weeks.
Spain and Italy’s bond yields eased this morning on the news. Spain’s ten-year bond yields were down 14 basis points to 6.8 per cent, after falling below the symbolic 7 per cent barrier. Italian bonds fell ten basis points to 5.79 per cent.
European markets also rose slightly on opening this morning.
Speaking at the Global Alternative Investment Management conference in Monaco, Mr Jenkins warned: “Those of you who traded asset backed securities in 2008 can testify to the speed with which liquidity can disappear. Yet despite these examples, many continue to assume that … ‘liquidity’ is free and will be freely available.
“Short-selling bans in Europe and bond purchase penalties in Brazil are a foretaste of the future. I recommend that you send your best and your brightest to the library to research state intervention in the post war period. It could come in handy. For like clean air and water, market liquidity is no longer limitless and no longer free.”
Markets are facing another crisis due to the resurgence of “cross-border” risks in the eurozone, he warned, and a calamity will not be averted unless confidence is comprehensively restored in the single currency project.
“Capital is leaving the very countries that need it – and flowing to the countries that don’t. At the same time financiers are cutting back on credit while they determine and manage their cross-border risk.”
The bailout for Spain and Italy follows intense pressure on Mrs Merkel and other European leaders at this week’s G20 summit to take radical action to stem the growing euro crisis which has pushed up the cost of Spanish bonds to unsustainable levels.
The communiqué issued at the end of the G20 summit, which finished in Mexico last night, said that European leaders had agreed to take action to bring down borrowing rates.
Under the proposed deal, two European rescue funds – the £400 billion (€500 billion) European Stability Mechanism (ESM) and the £200 billion (€250 billion) European Financial Stability Facility (EFSF) – will buy bonds issued by European countries.
Previously, money in these funds — which has been provided by members of the single currency — has been used to bail out smaller European countries such as Greece, Portugal and Ireland. Governments in these countries were offered money directly in return for agreeing to austerity programmes. Under the new plan, the money in these funds will not be given directly to governments but will instead be used to buy up debts on the financial markets.
The European Central Bank previously bought about £170 billion (€210 billion) of bonds in this way but stopped last year. It is hoped the new plan will drive down the cost of Spanish and Italian bonds by showing that the eurozone is prepared to stand behind the debts of its members.
President Barack Obama met David Cameron and other European leaders yesterday to discuss the proposed deal and an EU-American trade deal.
François Hollande, the French president, said that Italy had proposed using the eurozone’s new permanent bailout fund to buy the debt of member states saddled with high borrowing costs and that this was an idea worth exploring.
“Italy has launched an idea which is worth looking at,” he said. The proposale will be discussed at a meeting in Rome on Friday between him, Mrs Merkel, Spain’s Mariano Rajoy and Italy’s Mario Monti.
“We are looking for ways to use the ESM for this. At the moment it is just an idea, not a decision. It is part of the discussion,” he said.
Mr Hollande said rates paid by Spain and Italy to borrow on debt markets were unacceptable. “We must show a much faster capacity for action,” he said.
Germany is reported to be willing to do more, but has not yet indicated its support for the proposal.
Experts said it was a step towards establishing shared eurobonds, where debt from across the single currency area is shared and effectively underwritten by Germany.
At a press conference to mark the end of the G20 summit, David Cameron welcomed the assurances given by eurozone leaders.
He said: “What I’ve sensed at this summit is that there is a fresh impetus – using all the mechanisms, institutions, firepower they have.”
He added that European leaders would put the future of the euro “beyond doubt”. White House sources indicated that a “new framework” to shore up the single currency would be unveiled at next week’s summit in Brussels.
Timothy Geithner, the US Treasury Secretary, said the new deal would help Spain and Italy to borrow money at lower rates.
Last night, George Osborne, the Chancellor, indicated that he was optimistic a deal could be agreed. “We will see what the eurozone announce over the next couple of weeks, but there is no doubt that they realise that individual measures in individual countries – like recapitalising Spanish banks and getting a Greek government that is in favour of staying in the euro and doing what is necessary to stay in the euro — are not by themselves enough,” he said.
“These are systemic problems in the eurozone which require a systemic answer and we need to see measures from the eurozone that help bring borrowing costs down, that help ensure that there are common resources transferred from richer countries to poorer countries, that the whole eurozone stands behind the banks of the eurozone.”
He added: “The eurozone is inching towards solutions. Basically, we do need to see the richer countries, like Germany, like Holland, spend some of their resources in propping up the weaker countries of the eurozone.
“Obviously it is difficult for them to do that, it is not a popular thing to do but it is absolutely necessary.
“I think there are signs that the eurozone are moving towards richer countries standing behind their banks and standing behind the weaker countries.”
The emergence of an outline rescue deal for Spain and Italy comes after Spanish bond yields increased sharply to more than seven per cent after the re-run of the Greek election last weekend.
Talks continued yesterday between the main Greek political parties to form a new coalition government. The new administration, which is expected to be led by the New Democracy party, is likely to attempt to renegotiate the terms of the Greek bail-out. The new government is hoping to water down or delay the country’s austerity programme. However, this is likely to be blocked by the German government and it is feared that this may lead to renewed turmoil in Greece.
Alongside discussions of the eurozone deal at the G20 summit, world leaders agreed to increase resources to the International Monetary Fund (IMF). China offered another £27 billion, and countries including Brazil, Russia and India each pledged £6.3 billion, under a scheme to double the IMF’s fighting fund. The US refused to contribute further funds.
Christine Lagarde, the managing director of the IMF, said: “These resources are being made available for crisis prevention and resolution and to meet the potential financing needs of all IMF members.”
Leaders of major European countries meet in Rome on Friday ahead of a crucial EU-wide summit next week. Negotiations at the summit are expected to focus on plans for a European-wide banking union. However, this may prompt concerns in Britain over what safeguards will be offered to the City.
The Prime Minister will today travel to Mexico City for talks with the outgoing Mexican president. He may also meet Carlos Slim, the Mexican tycoon who is the world’s richest man.
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