Tuesday, May 11, 2010

$1 trillion to rescue Europe

The European Union's 27 finance ministers have agreed on the creation of a 'European stabilisation mechanism'. Photo / AP
The European Union's 27 finance ministers have agreed on the creation of a 'European stabilisation mechanism'. Photo / AP

European policymakers have unveiled an unprecedented loan package worth more than $1 trillion and a programme of bond purchases as they spearheaded a global drive to stop a sovereign-debt crisis that threatened to shatter confidence in the euro.

Jolted into action by last week's slide in the currency and soaring bond yields in Portugal and Spain, the 16 euro nations agreed to offer financial assistance worth as much as €750 billion ($1.3 trillion) to countries under attack from speculators. The European Central Bank will counter "severe tensions" by purchasing government and private debt.

"The message has gotten through: the euro zone will defend its money," French Finance Minister Christine Lagarde said after the 14-hour meeting.

Under pressure from the US and Asia to stabilise markets, the European governments gambled that the show of financial force would prevent a sovereign-debt crisis and muffle speculation that the 11-year-old euro might break apart.

The two-pronged offensive pushed up the euro 1.4 per cent. New Zealand's NZX-50 rose 0.37 per cent, while Australia's ASX200 climbed 2.66 per cent. In Japan, the Nikkei gained 1.6 per cent.
"This is Shock and Awe, Part II and in 3-D," said Marco Annunziata, chief economist at UniCredit Group in London.

"This truly is overwhelming force, and should be more than sufficient to stabilise markets in the near term, prevent panic and contain the risk of contagion."

The steps came after failure to contain Greece's fiscal crisis triggered a 4.1 per cent drop in the euro last week, the biggest weekly decline since the aftermath of Lehman Brothers' collapse. European stocks sank the most in 18 months, with the Stoxx Europe 600 Index tumbling 8.8 per cent to 237.18.

The ripple effect in the US, including a brief 1000-point drop in the Dow Jones Industrial Average, prompted President Barack Obama to call German Chancellor Angela Merkel and French President Nicolas Sarkozy to urge "resolute steps" to prevent the crisis from cascading around the world.

Under the loan package, euro-area governments pledged €440 billion in loans or guarantees, with €60 billion more in loans from the EU's budget and as much as €250 billion from the International Monetary Fund.

"I think they will have bought themselves a significant amount of time to do the right thing," said Barry Eichengreen, an economics professor at the University of California, Berkeley.

In a step that skirts EU rules barring direct central bank lending to governments, the ECB said it will conduct "interventions" to ensure "depth and liquidity" in markets.
The purchases will be sterilised, meaning they won't increase the overall money supply in the financial system.

The ECB also reactivated unlimited fixed-rate offerings of three-month loans, a key tool in the ECB's efforts to fight the credit crisis. It will also reactivate dollar swaps with the Federal Reserve.

In Brussels, finance ministers from the 16-nation euro region - joined by ministers from the 11 EU countries outside the euro - raced against time to weld the contingency lending arrangements before markets opened in Asia.

Inability to craft a convincing package in time would have left deficit-plagued countries at the mercy of the "wolfpack behaviour" of speculators, Finance Minister Anders Borg of Sweden, a non-euro member, said as the meeting began.

The new war chest would be used for countries such as Portugal or Spain in case their finances buckle.

Deficits are set to reach 8.5 per cent of gross domestic product in Portugal and 9.8 per cent in Spain this year, above the euro region's 3 per cent limit.

Both countries pledged "significant" additional budget cuts in 2010 and 2011, which will be outlined in May, an EU statement said.

Greece, the epicentre of the debt crisis, has already won a €110 billion aid package after agreeing to unprecedented austerity measures.

The cuts sparked riots in Athens last week, leading to three deaths and stoking concerns that the Government won't be able to implement all the steps.
European governments endorsed their €80 billion share last week, and the IMF cleared the way to pay its €30 billion share on Sunday.


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