Debt Contagion Fear Spreads in Europe as S&P Lowers Eurozone Credit Ratings

Standard & Poor's yesterday (Wednesday) lowered Spain's credit rating - just one day after downgrading the ratings of Greece and Portugal. The downgrades have prompted Germany to promise a quick release of Greece bailout funds as fears of a debt contagion spread rapidly across Europe.

"It is probably fair to say that Tuesday, 27 April was the day that the situation in the euro area took a dramatic and rather frightening turn for the worse," credit analysts at Credit Suisse (NYSE ADR: CS) in London said in a research note. "The concern is the extent and speed of the spreading of the crisis in an environment of too many financial obligations, not all of which will be serviced, in our view, and in a crisis which in our view is about far more than Greece."

S&P downgraded Spain's long-term credit rating one notch to AA from AA+ with a negative outlook, citing an extended period of low economic growth and high borrowing costs.

"We now believe that the Spanish economy's shift away from credit-fueled economic growth is likely to result in a more protracted period of sluggish activity than we previously assumed," said S&P analyst Marko Mrsnik. "We now project that real [gross domestic product] growth will average 0.7% annually in 2010-2016, versus our previous expectations of above 1% annually over this period."

The agency on Tuesday lowered Greece's rating to BB+ from BBB+, marking the first time since the euro's creation that a euro-using country fell below investment grade status. Portugal was cut two notches to A-.

Greece's securities market regulator banned short-selling on the Athens Stock Exchange for two months after the downgrade announcement rattled the markets. European shares hit a seven-week low Wednesday after posting the biggest one-day fall in five months on Tuesday. The euro hit a new 12-month low of 1.3120 against the dollar.

"It's not a question of the danger of contagion," Organization for Economic Cooperation and Development Secretary General Angel Gurria told Bloomberg. "Contagion has already happened. This is like Ebola. When you realize you have it you have to cut your leg off in order to survive."

Analysts predict the debt contagion will shake Italy next. The news of its " PIIGS" counterparts being downgraded caused a bond sell-off, with two-year bond yields rising from 1.95% to 2.08% Wednesday.

Tuesday's ratings cuts sparked a short-lived U.S. stock sell-off as the Dow Jones Industrial Average fell 213.04 but regained some footing. The blue-chip index rose 54.41 points to close at 11,046.40. Analysts credit the rise partly to better-than-expected first-quarter corporate earnings reports, and partly to investors pulling money farther away from Europe.

Germany Sets Bailout Timeline

German finance minister Wolfgang Schauble met with International Monetary Fund head Dominique Strauss-Kahn and European Central Bank president Jean-Claude Trichet in Berlin Wednesday to discuss aid disbursement as the debt contagion fear picked up momentum.

"It's completely clear that the negotiations between the Greek government, the European Commission and the IMF need to be speeded up now," said German Chancellor Angela Merkel.

Germany has been stalling the release of funds as Merkel faces an upcoming May 9 election and strong voter opposition of supporting debt-plagued Greece.

Greece needs to receive an aid package by May 19 to meet maturing debts. Finance minister Schauble announced after the meeting that Germany could have its $11.09 billion (8.4 billion euro) contribution approved by parliament by the end of next week. Germany is the biggest single Eurozone contributor to the bailout.

German lawmakers also reported that over a three-year span Greece would receive much more aid than originally announced, reaching between $132 - $158 billion (100 and 120 billion euros). The $60 billion (45 billion euro) aid package requested by Greece last week would only cover this year's debt obligations. The IMF did not confirm the increased funds.

While European policy makers have attempted to dampen debt contagion fears, some economists blame the leaders' slow reaction for worsening the situation.

"The hesitant and haphazard reaction of euro-zone policymakers to Greece's predicament underscores the dangers of contagion," Marco Annunziata, chief economist at UniCredit Group in London, told Bloomberg. "The euro-zone has taken over six months to react and is allowing uncertainty to persist. This does not bode well for their ability to react quickly should a second flashpoint burst."

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