Greek vote sets off 'pandemonium', engulfs Italy

Greece's startling decision to call a referendum on last week's EU summit deal has set off wild tremors across the eurozone, pushing Italy to the brink of a perilous downward spiral.

the Telegraph,

By Ambrose Evans-Pritchard

8:35PM GMT 01 Nov 2011

The country's ruling Pasok party appeared to be splintering on Tuesdsay night, leaving it unclear whether the governent of premier George Papandreou can survive a parliamentary vote of confidence on Friday.

Signs that the EU's pain-stakingly negotiated Grand Plan is unravelling within days has been a profound shock to confidence.

A frantic search for safe havens led to the second biggest one-day fall ever recorded in Europe's AAA bond yields. Ten-year German Bund yields tumbled 25 basis points to 1.77pc, with similar moves in non-EMU Swedish and Danish debt. British Gilt yields fell to 2.2pc.

Italy took the brunt of the punishment. Spreads over Bunds spiked to a crisis-high of 459 basis points before the European Central Bank came to the rescue. Spanish spreads reached 384.

Andrew Roberts from RBS said Italy's debt stress is "dangerously close to a level that could cause pandemonium in financial markets".

The point of no return - judging from the sequence in Greece, Ireland and Portugal - would most likely be if LCH Clearnet imposed higher margin requirements. This trigger is 450 points over a basket of AAA benchmark bonds. The spread reached 388 on Tuesday. "We're two more days of violence from this point, but we're not there yet," he said.

The Greek move - denounced by France's Elysee as "irrational and dangerous" - raises the serious possibility that a euro member could soon be forced out of the monetary union, setting a precedent with explosive ramifications for other states in trouble.

"I would have liked to do without this piece of news," said Eurogroup chairman Jean-Claude Juncker. "It is something that brings a great nervousness, that adds great insecurity to already great insecurity."

Mr Juncker said a "no" vote by Greek citizens would set in motion events that could lead to bankruptcy and threaten Greece's foothold in Europe.

"If the Greek people say no to everything that has been agreed so far, then I don't see either how we can continue with the Greeks on good terms," he said.

If is far from clear how Greeks might vote. A Kappa Reserach poll found that 80pc oppose the EU-IMF "Memorandum", but far less would vote against it, and 70pc want to stay in the euro. The EU's haircut deal leaves Greece with debt of 120pc of GDP in 2020 - if all goes well - after nine years of austerity and slump.

However, quest for membership of every part of the EU system has been central to Greece's foreign policy since the return to democracy in the 1970s. For Greeks, cut off in the furthest corner of the Balkans, and cheek by jowl with the Near East, European identity has almost sacred importance.

While it is likely that the Greeks would vote "yes", the referendum ensures weeks or months of eurozone chaos and calls into question every component of the EU rescue package.

China, Japan, Russia and Brazil have already reacted coldly to calls to rescue Euroland by playing a direct role in the EU's bail-out fund (EFSF). They are likely to keep an even wider berth now that monetary union is once again proving unmanageable without an economic government to back it up.

Yu Yongdin, a former Chinese rate-setter, told Europe not to expect too much. "Eurozone countries will have to save themselves. Expectations of a 'red knight' are sorely misplaced."

Jacques Cailloux, Europe economist at RBS, said the Greek demarche is an ugly turn of events. "This added uncertainty will likely block any new potential financial support from countries outside monetary union to the EFSF," he said

"In the current situation, the ECB remains the only credible backstop and will be forced to step up massively its bond purchases to prevent a new escalation of contagion risks."

The crisis in Italy is a nightmare debut for the ECB's new president Mario Draghi, who took over on Tuesday from Jean-Claude Trichet - viewed by Frankfurt as more German than the Germans.

Mr Draghi, former head of Italy's central bank, is in an awkard position where his first act in office is to oversee the purchase or "monetisation" of Italian bonds. If he presides over a cut in interest rates on Thursday - as demanded by the OECD and a chorus of global voices - the move will inevitably fuel suspicions among German and Dutch hardliners that the ECB has turned Latin.

"He had better find himself a German grandmother fast," said Hans Redeker, currency chief at Morgan Stanley.

The collapsing credibilty of Silvio Berlusconi's coalition in Rome is bringing matters to a head. The Democrat opposition called on Italy's president to appoint a salvation government immediately. "This is an urgent necessity to face the coming storm," it said.

The bail-out machinery was already under scrutiny before Greece's move. Plans to leverage part of the EFSF four or five times to €1 trillion, by using it as a "first loss" bond insurer, concentrates risk for the six AAA states that underpin the fund. The danger is that this will cost France its AAA rating, accelerating contagion to the eurozone core.

Critics say this is a massive design flaw in the concept and will never gain market acceptance. Mounting evidence that Europe is tipping back into slump may, in any case, finish off the idea. Standard & Poor's has warned that it will cut France's rating by up to two notches if there is an EMU recession.

John Higgins from Capital Economics said events are closing in on Euroland. "We expect the crisis to build, prompting a prolonged recession in the eurozone, and at some point the end of the euro itself in its current form."