European finance ministers have been warned confidentially of the danger of a renewed credit crunch, as a "systemic" crisis in eurozone sovereign debt spills over to banks.
In a report prepared for ministers meeting in Poland on Friday and Saturday, obtained by press agency Reuters yesterday (14 September), senior EU officials said the 17-nation currency area faced a "risk of a vicious circle between sovereign debt, bank funding and negative growth".
"While tensions in sovereign debt markets have intensified and bank funding risks have increased over the summer, contagion has spread across markets and countries and the crisis has become systemic," the influential Economic and Financial Committee said.
"A further reinforcement of bank resources is advisable," ministers were told in language that echoed an International Monetary Fund call for urgent action to recapitalise European banks.
The report highlighted European policymakers' challenge to restore confidence as the leaders of Germany, France and Greece held a crucial conference call on efforts to avert a Greek default that could cause a global financial shock.
Moody's Investors Service downgraded two of France's top banks, Societé Générale and Credit Agricole, saying its concerns about their funding and liquidity profiles had increased in the light of worsening refinancing conditions.
The ratings agency left France's largest bank, BNP Paribas, on review, saying its profitability and capital base gave it an adequate cushion to support its Greek, Portuguese and Irish exposure.
The euro and European stocks were earlier boosted by an announcement by the head of the European Commission that the EU executive would soon present options for issuing a common eurozone bond, despite fierce resistance in Germany.
Many investors see joint debt issuance as the best way out since it would reassure markets that Europe's strongest economies were taking responsibility for weaker states.
But there is strong political opposition in northern Europe to underwriting the debts of what are seen as profligate southern states, making euro bonds a distant prospect.
European Commission President José Manuel Barroso told the European Parliament that closer union, particularly in the euro area, was the only way to reverse the negative cycle in financial markets.
"Today I want to confirm that the Commission will soon present options for the introduction of Eurobonds. Some of these could be implemented within the terms of the current treaty, and others would require treaty change," he said.
But he warned that such bonds were no silver bullet to end the crisis, and could only be part of a comprehensive plan.
China added its voice to US concerns over Europe's apparent inability to stop debt contagion spreading, while Indian and Brazilian officials said major emerging economies were discussing increasing their euro sovereign holdings.
US Treasury Secretary Tim Geithner urged European leaders to act more forcefully to solve the escalating crisis, saying they have the economic and financial capacity to do so.
With senior EU and IMF inspectors due in Athens on Monday to check Greece's faltering compliance with its bailout plan, German Chancellor Angela Merkel and French President Nicolas Sarkozy urged Greek Prime Minister George Papandreou to implement austerity measures to meet fiscal targets, a French statement said.
"Despite recent rumours, all parties stressed Greece will remain in the euro zone," Greek government spokesman Ilias Mossialos said after the 25-minute telephone call.
A Greek official said after the call that Athens now expected the EU/IMF "troika" to report that Greece was on track to meet its 2011-12 targets after the latest additional austerity measures announced last weekend.
EU Economic Affairs Commissioner Olli Rehn said issuing common eurozone bonds would require much more intrusive surveillance of member states' fiscal and economic policies, which would have to be fully debated in each country.
A German Finance Ministry spokesman reaffirmed Berlin's opposition to the idea but said it was awaiting the proposals.
Merkel, Sarkozy reject calls for orderly Greek default
Merkel and Sarkozy have reaffirmed their support for Greece remaining in the euro zone and rejected calls for an "orderly insolvency" of the debt-laden nation.
The leaders, who held a telephone conference with Greek Prime Minister Georges Papandreou yesterday evening, reportedly said they were convinced that Greece's future lay in the euro zone.
They also underlined that it was "more [essential] than ever before" to fully implement decisions taken by eurozone leaders on 21 July to ensure the stability of the euro zone.
Stop crisis from spreading
China and the United States both voiced concern that eurozone governments may be losing control of the debt crisis.
Chinese Premier Wen Jiabao said Beijing was willing to help its biggest trading partner, but added that Europe must stop the crisis – which now threatens Italy – from growing.
"What we have to take note of now is to prevent the sovereign debt crises from spreading and expanding further," Wen said on Wednesday in an apparent response to pleas to buy more eurozone government bonds.
Credit markets are factoring in a 90% chance that Greece will default on its debts and they demanded the highest risk premium on Italian five-year bonds at auction on Tuesday since the country joined the euro.
Italian Prime Minister Silvio Berlusconi's government won a parliamentary confidence vote on a 54-billion-euro austerity package, which lawmakers were to finalise later in the day. The moves have done little so far to stem doubts about whether the euro area's third-biggest economy can manage its debts.
Greece, Ireland and Portugal have all received EU/IMF rescue packages, but many see Italy as too big to bail out.
EURACTIV with Reuters
Since the euro zone's debt crisis erupted last year, the region's governments have aimed to limit it to Greece, Ireland and Portugal, which have so far signed up to bailouts totalling almost €400 billion.
Spain and Italy had managed to keep their access to market funding under control through fiscal reforms.
But in recent weeks the situation has worsened. Due to the large size of the Spanish and Italian economies, pressure on the euro zone would increase dramatically if either country were to need financial assistance.
EU officials have avoided any talk of budget offenders like Greece being kicked out of the euro zone but the Netherlands put the unwanted question firmly back on the table on 8 September, with proposals to appoint a new "commissioner for budgetary discipline".
- Wall Street Journal:Any Exit Strategies Go Right Out The Door for Euro-Zone Members
- Daily Mail:Britain draws up survival plans for life after the euro to avoid plunging into another recession
- Reuters:Euro wobbles as relief over Greece faces
- Bloomberg:Asian Stocks Rise as Germany, France Say Greece’s Future is in Euro Area