Euro Leaders Aim to Buy Time to Save Currency

By Patrick Donahue - Jan 2, 2012 6:00 AM GMT+0700

European leaders return to work from Christmas holidays seeking to buy time for the Spanish and Italian governments to wrest control over their debt and rescue the single currency from fragmentation as the region’s crisis enters a new year.

Some 157 billion euros ($203 billion) in debt will mature in the 17-member euro area in the first three months of 2012, according to UBS AG. By the end of that period, leaders have pledged to draft a stricter rulebook for controlling government spending. German Chancellor Angela Merkel and French President Nicolas Sarkozy will meet in Berlin Jan. 9 to work out details.

“The path to overcoming this won’t be without setbacks, but at the end of this path, Europe will emerge stronger from the crisis than before,” Merkel said in a New Year’s speech broadcast Dec. 31. She said that her government will do “everything” to bring the euro out of the slump.

On the 10th anniversary of the introduction of the euro bank notes that replaced national currencies, the euro for the first time had two consecutive annual losses against the U.S. dollar and plunged to a record low against the yen. European leaders are struggling to hold the monetary union together in the face of credit downgrades, emerging splits in the European Union and a looming recession that could compound rising debt.

Italy’s EU53 Billion

The latest crack appeared Dec. 30, when Spain’s new government said 2011’s budget deficit would reach 8 percent of output, 2 percent more than the previous government had projected and more than the 6.9 percent expected by economists surveyed by Bloomberg. Prime Minister Mariano Rajoy responded by unveiling a new package of spending cuts and tax increases.

Still, the key to the euro’s survival may lie with Italy, the group’s third-largest economy and the second most-indebted after Greece. The government in Rome must repay 53 billion euros in debt in the first quarter, about a third of the euro area’s total amount for the period, after Prime Minister Mario Monti passed an emergency budget package aimed at curtailing borrowing costs.

Italy’s 10-year yield ended 2011 near the 7 percent mark that led Greece, Ireland and Portugal to seek bailouts. Spain’s equivalent yield finished the year just above 5 percent.

“If the Italian yields start to rise, you could quickly turn a manageable situation into an insolvent one,” Michael Spence, a professor of economics at New York University and a Nobel laureate, said on Bloomberg Television Dec. 28. “Italy needs time and Europe needs to help buy them some of the time.”

Sarkozy

German Finance Minister Wolfgang Schaeuble echoed that strategy, telling the Bild newspaper yesterday that European rescue funds can only “buy time” before indebted states take “the necessary measures to win back confidence.”

The euro lost 3 percent against the dollar last year, ending at $1.2961, a decline of 13 percent from its 2011 high of $1.4830 on May 2. It lost 3.2 percent in the last quarter.

France’s Sarkozy said that his government will turn from budget fighting to economic growth and unemployment in 2012, which will be “the year of all risks and of all possibilities,” he said Dec. 31 in his fifth New Year’s address, the last he will give before facing a re-election contest in May. Sarkozy will meet with Italy’s Monti in Paris on Jan. 6.

In a New Year’s message given to Greek citizens, Prime Minister Lucas Papademos said his nation will confront a “difficult” 2012 and said that the “next three months will be particularly crucial.”

Greek Debt Swap

Papademos, appointed on Nov. 11 as head of a government backed by three of the five parliamentary parties, is trying to secure loans under a 130 billion-euro bailout for Greece agreed to in October by European Union leaders before elections are held. Measures include negotiating a debt swap with private creditors that will cut 100 billion euros off Greece’s burden.

As Europe’s leaders tinker at a new budget framework and craft the so-called firewall that will prop up ailing states, Bundesbank President Jens Weidmann said that the European Central Bank won’t “step into the breach for fiscal policy.”

“We have to make it clear where our legal, but also our real limits, are,” Weidmann, who is a council member of the Frankfurt-based ECB, told Tagesspiegel newspaper yesterday.

Fiscal and monetary efforts could be hampered by a shrinking economy in the euro area, which would crimp tax revenues and fuel unemployment. The economy of the 17-nation area will shrink by about 0.7 percent this year, said Howard Archer, an economist at IHS Global Insight in London.

“We expect eurozone recession to occur in late-2011 and the first half of 2012 in the face of the ongoing eurozone sovereign debt crisis,” Archer wrote in a Dec. 30 note to clients. “It is vital that eurozone policymakers get a real grip on matters quickly.”

To contact the reporter on this story: Patrick Donahue in Munich at pdonahue1@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net