EU Commissioner for Economic and Monetary Affairs Olli Rehn.GEORGES GOBET/AFP / Getty Images
The debt crisis that began in the euro zone's smaller peripheral states is rapidly taking root in France and other core countries, raising their borrowing costs and putting the survival of the monetary union on the line.
The spreading contagion, long feared by euro watchers, spells the beginning of the end for the single currency union unless key policy makers take drastic steps soon, warns a growing chorus of alarmed politicians, business executives, bankers, investors and economists.
"This crisis is hitting the core of the euro zone," European economic and monetary affairs commissioner Olli Rehn said in Brussels. "We should have no illusions about this."
France, the Netherlands, Belgium and Austria have all watched borrowing costs climb sharply, as bond investors dodge most euro zone public debt, apart from German bunds. The selloff continued Monday despite the election of a conservative majority government in Spain committed to tougher austerity measures. Indeed, Spanish rates climbed close to their peak since the crisis first hit the struggling but still solvent country.
The bond exodus reaches across the euro zone, leaving only two major buyers: the European Central Bank, whose purchases are limited in size by the governing council; and institutions that are only interested in their own country's bonds.
Leaving out insolvent Greece, Portugal and Ireland, which were shut out of the market long ago, the freeze puts at risk about €800-billion ($1.121-trillion) worth of debt financing required next year by euro zone governments. And it comes as German and ECB officials continue to dismiss demands from France and other governments to bolster the ECB's bond-buying capacity and issue region-wide euro bonds with strong guarantees, as a means of restoring the markets' shattered confidence.
"What rarely happens any more is that a French institution buys Italian bonds or an American institution buys Spanish bonds or an Asian institution buys a particular bond," said Peter Schaffrik, head of European interest rate strategy with Royal Bank of Canada in London.
The rapid morphing of the crisis into a potential euro-breaker prompted one bond manager, Andrew Balls, head of European portfolio management at Pimco, to lump both core and peripheral countries together as the shunned EEGs: Everyone Except Germany.
The European government bond market is broken, Mr. Schaffrik declared.
Joint euro-bonds are no remedy, insisted Juergen Stark, a member of the ECB's executive board and a leading hawk, in an Irish TV interview on Monday. And ECB council member Ewald Nowotny declared in Vienna that governments should not rely on the central bank to attack the debt crisis by printing money.
Spreads between 10-year government bond yields in several core countries and comparable German debt have reached levels far above their averages since monetary union, John Higgins, senior markets economist with Capital Economics in London, said in a note. This is occurring "not because investors now expect tighter monetary policy, but because they are increasingly concerned that policy makers will not be able to contain the crisis and perhaps even keep the euro zone together at all."
Germany itself faces a growing risk of sliding into the recession now gripping the region's weakest economies. Citing "financial market nervousness" and a sharp decline in export demand, the German central bank, the Bundesbank, has slashed its growth forecast for next year to between 0.5 and 1 per cent, from 1.8 per cent in June.
Bundesbank president Jens Weidmann said on Friday that the crisis threatens the global economy. But its immediate impact is still being felt close to home.
France has a large fiscal hole and a debt-to-GDP ratio of more than 82 per cent. Belgium's debt level is even higher, at 96 per cent, while the Dutch ratio is a manageable 63 per cent. But none relishes the prospect of tacking on billions of euros in added financing costs to mollify investors worried about the euro's possible demise.
"We seem to have entered the last days of the euro as we currently know it," Credit Suisse economists warned in a report Monday. They were referring not to a complete breakup of the euro zone, but the intensifying pressure on Germany, France and other core countries to quickly adopt a credible version of fiscal integration if they want to keep their union from disintegrating.
The crisis cannot be resolved in the short run "by the ECB or by new governments in Greece, Italy or Spain," Credit Suisse said. "It's about markets needing credible signals on the shape of fiscal and political union long before final treaty changes can take place."