European leaders unveiled an unprecedented loan package worth almost one trillion US dollars and a program of bond purchases in an attempt to bolster the Euro that has become highly vulnerable because of the Greek sovereign-debt crisis.
Jolted into action by last week’s slide in the Euro and soaring bond yields in Portugal and Spain, the 16 Euro nations agreed to offer financial assistance worth as much as 750 billion Euros (962 billion US dollars) to countries under attack from speculators. Furthermore, the European Central Bank (ECB) will counter “severe tensions” in “certain” markets by purchasing government and private debt.
“The message has gotten through: the Eurozone will defend its money,” French Finance Minister Christine Lagarde told reporters in Brussels early Monday, after the 14-hour meeting.
Under pressure from United States and Asia to stabilize markets, the European governments expect that the financial Europe fortress can prevent a major sovereign-debt crisis and contain speculation against the 11-year-old Euro.
The first reactions of the two-pronged offensive pushed up the Euro 1.4% in Tokyo while the Nikkei 225 Stock Average climbed 1.3% to 10,499.25.
The steps came after failure to contain Greece’s fiscal crisis triggered a 4.1% drop in the Euro last week—the biggest weekly decline since the aftermath of Lehman Brothers Holdings Inc.’s collapse. European stocks sank the most in 18 months, with the STOXX Europe 600 Index tumbling 8.8% to 237.18.
The ripple effect in the US, including a brief 1,000 point drop in the Dow Jones Industrial Average (INDEXDJX:.DJI) on May 6, prompted President Barack Obama to call German Chancellor Angela Merkel and French President Nicolas Sarkozy to urge “resolute steps” to prevent the crisis from cascading around the world.
Under the loan package, Eurozone governments pledged 440 billion Euros in loans or guarantees, with 60 billion Euros more in loans from the European Union budget and as much as 250 billion Euros from the International Monetary Fund (IMF).
In a step that skirts EU rules barring direct central bank lending to governments, the ECB said it will conduct “interventions” to ensure “depth and liquidity” in markets. The purchases will be sterilized, meaning they won’t increase the overall money supply in the financial system.
The ECB also reactivated unlimited fixed-rate offerings of three month loans, a key tool in the ECB efforts to fight the credit crisis. It will also reactivate dollar swaps with the US Federal Reserve and several other central banks from Canada, England, Japan while talks for further adhesion continue.
In Brussels, finance ministers from the 16-nation Euro region—joined by ministers from the 11 EU countries outside the Euro—raced against time to weld the contingency lending arrangements before markets opened in Asia. Inability to craft a convincing package in time would have left deficit-plagued countries at the mercy of the “wolf-pack behavior” of speculators, Finance Minister Anders Borg of Sweden—a non-Euro member—said as the meeting began.
The new war chest would be used for countries like Portugal or Spain in case their finances buckle. Deficits are set to reach 8.5% of GDP in Portugal and 9.8% in Spain this year, above the Euro region’s 3% limit. Both countries pledged “significant” additional budget cuts in 2010 and 2011, which will be outlined in May, an EU statement said.
The extra yield that investors demand to hold Greek, Portuguese and Spanish debt instead of benchmark German bonds rose to Euro-era highs last week. The premium on 10-year government bonds jumped as high as 973 basis points for Greece, 354 basis points for Portugal and 173 basis points for Spain.