Investors'concerns about the eurozone’s rescue plan for Greece and fears of a global economic slowdown have refocused attention on the euro with Spain and Italy facing renewed pressure.
Investors’concerns about the eurozone’s rescue plan for Greece and fears of a global economic slowdown have refocused attention on the euro with Spain and Italy facing renewed pressure.
Barely two weeks after eurozone leaders agreed to a second bailout for Greece and adopted a series of measures to prevent the crisis spreading to other countries, uncertainty has returned to the markets with no end in sight to the turmoil.
Investors are also concerned that the European bail-out mechanism agreed by the European leaders will not be big enough to deal with crises in Italy or Spain, the EU's third and fourth largest economies.
In early trading on Wednesday, the yield on Italian and Spanish 10-year bonds rose to 6.21%, and 6.34% respectively, just below 6.25% and 6.45% on Tuesday. These levels are considered dangerously close to 7% which many economists say is unsustainable.
The premiums that Spain and Italy have had to pay to borrow above Germany have also reached record highs this week, bringing them close to levels that previously pushed Greece, Ireland and Portugal into bail-outs.
Jeremy Cook, chief economist at World First foreign exchange, said Spanish and Italian bond yields rose as investors became more and more nervous about the funding position of the two governments and this is difficult to reverse.
"Unfortunately there is not much that will bring these yields lower in the short term given the thin trading conditions we see in August. It is said that markets tend to trade on a path of least resistance, at the moment that path is one that involves hammering peripheral European assets and dragging the Italian economy further into the mire," he said.
Analysts said there is not much that Italy and Spain can do to calm the markets. Italy's parliament already approved a €43bn austerity programme last month though there are concerns about the government’s ability to enforce the cuts and about the lack of structural reforms.
Spain has already imposed tough austerity policies to cut its budget deficit and implemented structural and financial reforms to tackle a banking crisis.
The renewed crisis caused Spanish and Italian politicians to abandon their holiday plans to face the onslaught.
Italian finance minister Giulio Tremonti has held emergency talks with Jean-Claude Juncker, chairman of the group of finance ministers from the eurozone countries. Prime Minister Silvio Berlusconi is also due to address the Italian parliament later today to try to calm the markets.
In Spain, prime minister José Luis Rodríguez Zapatero returned to Madrid from his holiday retreat, amid growing fears the country could be forced into a bail-out.
German Economics Minister Philip Roesler had earlier sought to reassure the markets saying Italy and Spain had not even been discussed at the weekly cabinet meeting on Wednesday. There was no reason for alarm about economic growth, he said.
Nevertheless the fact that many policymakers are on holiday makes a response more difficult, though Zapatero said eurozone governments had been in contact by telephone about the situation.
New powers granted to the European Financial Stability Facility (EFSF), the eurozone's rescue fund, allowing it to support governments by purchasing bonds or extending precautionary credit lines to countries facing difficulties, cannot be used until they are approved by each national parliament.
Some countries would like the European Central Bank (ECB) to reactivate its own bond-buying programme to help countries through the crisis, but it has not shown any signs of doing this so far.
Worries about the global economy are also depressing investor sentiment, according to Trevor Greetham, manager of the funds and director of asset allocation at Fidelity International.
"The negative market reaction to the US debt deal and euro summit, supposedly good news events, suggests a downswing in global growth is gaining momentum – a view confirmed by our lead indicators. In Europe, the rise in Italian and Spanish government bond yields is worrisome and in our view reflects the slowdown in global growth and not a lack of austerity," he said.
The crisis has also sent investors flying into safe havens causing a sharp increase in the Swiss franc despite warnings that the currency was "massively overvalued" from the Swiss National Bank (SNB). This was threatening the development of the economy and increasing downside risks to price stability in Switzerland.
"The SNB will not tolerate a continual tightening of monetary conditions and is therefore taking measures against the strong Swiss franc," it said in a statement. It unexpectedly cut interest rates today and said it will increase the supply of francs to the money markets in order to stem its rapid appreciation.