November 18, 2010

Ireland Steps Back From Brink as Bailout Expected

Greek plight ticking down to deadline, with rescue questionable

Ireland’s situation, which had grown more tenuous as fears spread of default, eased on Thursday. While on Wednesday Ireland had still insisted it did not need outside assistance, the story changed the next day as Patrick Honohan, Ireland’s central bank governor, said he expected loans of “tens of billions” of euros.

Honohan spoke prior to a meeting with the European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF). According to a Reuters report, he told state broadcaster RTE that “[t]he intention is and the expectation is, on their part and personally on my part, that negotiations or discussions will be effective and a loan will be made available and drawn down as necessary.”

Although on Wednesday EU ministers had agreed that the EU, the ECB and the IMF would begin talks on a bailout, they did say Ireland would have to decide for itself to accept it. In a Reuters report, Brian Cowen, Ireland’s prime minister, had indicated that the country itself was not in need of assistance, but the banks might have to be rescued.

European stock and bond markets and the euro had dropped for 10 straight days as the situation worsened, but seemed to draw a breath on Thursday as word spread of the pending bailout. In the U.S., stock index futures edged higher as well.

Jean-Claude Juncker, Eurogroup chairman, had promised that the eurozone would be defended. Sixteen nations make up the currency zone. After talks on Tuesday, Juncker said at a news conference, "The discussions that will take place between Ireland and the Commission and the ECB and the IMF will enable us to have at our disposal all the elements and instruments we need were Ireland to make a request for assistance to the EU, the IMF and the Eurogroup."

They didn’t plan on waiting long to put the strategy into effect, either. Sources said that even though the plan was to focus on the Irish banks, once the mission was complete a rescue would be triggered for more than the banking sector. France’s Economy Minister Christine Lagarde said, “If you ask me whether that is a question of six months or of days, I would say we are closer to a question of days rather than six months.” That has apparently proved to be true.

Now that rescue is in the air, France has indicated that as a condition of its bailout, Ireland might have to raise its corporate tax rate. Dublin had been fighting against just such a measure. Lagarde said in a Reuters report that that rate, at only 12.5%, is abnormally low by European standards. She told France-Inter Radio that ". . . we will have to see how these [corporate] rates can be changed without weighing down the Irish economy and driving away investors.”

Bloomberg reported Wednesday that Ireland was preparing to open its banks’ books on Thursday to the EU and IMF. The inspection had been intended to decide whether Ireland could continue to work on its own to correct its problems or whether funds would be needed from the European Financial Stability Facility (EFSF). The EFSF holds $1 trillion (750 billion euros) against just such an eventuality.

Britainhas said that it will support a rescue for Ireland. Previously it had kept itself out of the eurozone in an effort to keep Ireland’s troubles from spreading to the rest of the U.K. It also had not contributed to the rescue package for Greece, but George Osborne, the chancellor of the exchequer, was quoted as saying the country “stands ready to support Ireland.”

Gold fluctuated early in the day Wednesday as the markets watched events unfolding over Ireland and Greece, then held steady for much of the day, according to TheStreet, after dropping 1.5% of its value on Tuesday’s selloff. Demand for gold has been rising steadily, and the GLD ETF held firm despite selloffs on Friday and Tuesday as investors held their shares. Thursday morning saw gold prices rising  more than 1% on the expectation of relief for Ireland. Still, as long as there is uncertainty about other countries with potential problems—Spain and Portugal as well as Greece—in addition to worries about a further rise in China’s interest rate, gold’s gains may be scant.

Irish bonds were up, and the 10-year yield dropped to 8.16%—a drop of 8 basis points. European stocks and the euro both rose as talks continued on the potential rescue package, with stocks breaking a seven-day losing streak to come back from their worst loss in four months. Anticipation of help in the form of a bailout helped to stem fears of contagion.

However, there is still the Greek situation waiting in the wings. Carl B. Weinberg, chief economist at High Frequency Economics, said in his Wednesday newsletter that Austria said Tuesday it will withhold funds at least until January “because Greece has not lived up to its fiscal commitments.” Wednesday’s news was no better: EU ministers, he said, “announced that all the governments will hold back their decision on Greece’s next cash disbursement until January.”

In response, Greece’s finance ministry issued a statement that said Athens expected the IMF board to approve the payout at its December board meeting and that ECOFIN will approve it in January. The statement also said that the delay in disbursement will not cause a problem. Weinberg pointed out that the disbursement was planned for Nov. 30 in the expectation that it would be needed by then, and wondered whether this disruption in schedule would indeed be so easily tolerated by a nation that has not been able to come up to scratch.

“A renewed Greek crisis,” he said, “will drive up risky Euroland sovereign debt yields—both absolutely and relative to Bunds—trash the euro and seize up the banking system . . . at a minimum. . . . The clock is ticking.”

The countdown continues till Nov. 30, when the next tranche of funding should be released to Athens, but as of Wednesday Austria had been holding firm against releasing its share because of what it said was Greece’s failure to comply with its agreement. On Thursday, however, a Reuters report said that the EU denied delaying that tranche, which contradicted what Austria’s finance minister had said. Greece planned to present a new budget on Thursday as well that would see tax hikes on goods, as it pressed to raise additional funds and meet its targets.

Greece’s finances are currently undergoing an audit by the EU, IMF and ECB. Funding for the troubled country depends on the findings of the auditors, who can say yea or nay on whether further tranches should be released to support Athens as it struggles to right itself.

To read more about the EU crisis, Ireland, and the effect on bonds, go to AdvisorOne.com.

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