Europe braces against the prospect of credit crunch deepening

Prospect of credit crunch deepens in Europe as markets witnessed massive selling of European government bonds by financial institutions around the globe. Such was the fear that not only new bond issues were shown the doors, but short term loans to reputed European banks were also cancelled.

Low investors’ confidence on European government bonds is believed to be linked with little information about the actual credit status of European banks and the way they are handled. Already Asian investors have started pulling out from European markets. Even Rabobank with AAA-credit rating, considered among the best European banks, had his loan cancelled by American institution, Vanguard.

On Friday, Mario Draghi, the newly appointed president of European Central Bank, has urged the countries affected by debit crisis to come to their own rescue instead of depending on the central bank.

It is feared that if selling pressure continues, higher borrowing costs, more cost cutting and slower growth would plague wider Europe. Euro zone banks are already in deep crisis trying to meet the rising borrowing costs. This is despite half a trillion cash inflow (in Euro currency) in debt from the European Central Bank. But this has little effect on the negative growth story in Europe so far. Already German bonds and Swedish bonds have started showing weakness. They are not strong as they used to be. Though they still are a safer bet than other European bonds – French, Spanish or Italian bonds.

European debt crisis threat as Italian Bonds touches new high

The fear of European debt crisis became more pronouned on Wednesday as Italian government bond spiked to a new high of 7 percent plus. Italian market tumbled in the afternoon as bonds breached the important threshold of 7 percent, triggered by the fear that EU has no rescue plan for Italy. This had a spiraling effect on other world markets, including Asian markets on early Thursday.

Italy, a core Euro zone member and the 8th largest world economy, is the world’s third largest bond market. Its debt amounts to a huge 2.6 trillion Euros – considered too much to be absorbed by EU.

German chancellor, Angela Merkel, warned that unless concrete and quick structural reforms take place to cut cost, it could result in collapse of the Euro currency. Angela Merkel has also demanded changes in the EU treaties.

The European Central Bank has bought, until recently, large chunks of Italian bonds to cut back its borrowing cost. But it is unlikely that the bank will be willing to buy any more after the new high.

As the resignation of Italian Prime Minister, Silvio Berlusconi, is still a month away, investors confidence has gone southward. Experts feel that Wednesday’s market reaction is not because of its poor fundamentals but because of fear of instability triggered by lack of decisive action on the part of Italian Premier.