Bond sell-offs fuel fears that Ireland, Portugal will go the way of Greece

Sept. 21 (Bloomberg) -- European Commission President Jose Manuel Barroso talked with Bloomberg's Sarah Eisen about the sovereign debt crisis in Ireland and Greece. (Source: Bloomberg)
By Anthony Faiola
Tuesday, September 28, 2010; 8:28 PM

LONDON - Fears that Europe could see another Greek-like debt crisis unfold in Ireland or Portugal escalated Tuesday, with investors selling off their bonds and analysts warning that both nations might be heading into critical periods that could trigger bids for bailouts.

The mounting problems in two of Europe's smallest economies are emerging as the biggest threat to an otherwise robust recovery underway in the major economies of the region, including Germany and Britain. Deteriorating conditions in Ireland and Portugal have already pushed the euro off a five-month high against the dollar, causing fresh jitters in stock markets across the region and beyond.

A sharp turn for the worst, analysts say, could spark a new round of financial turbulence in global markets from New York to Hong Kong, last seen when Greece's finances spiraled out of control over the summer. That crisis led to an emergency rescue by the Washington-based International Monetary Fund and the European Union.

Concern has been growing for weeks. But on Tuesday, investors punished Ireland in particular after a warning by Standard & Poor's that it might further downgrade Irish bonds as the cost of that nation's government bank rescue potentially reaches backbreaking levels. In Portugal, attempts to rein in runaway spending are falling far short of promises, prompting fear that it might need to follow Greece, which late last spring secured a $145 billion sovereign debt bailout from the IMF and E.U.

Ireland remained the primary focus of attention. Initially, the island nation of 4 million escaped the worst of the fallout from the Greek crisis by vowing to make painful spending cuts, reducing payments to everyone from widows to the blind. Since then, however, the cost of rescuing its troubled financial institutions, particularly the massive Anglo Irish Bank stung by the collapse of the Irish real estate boom, have soared. S&P warned the cost could reach a staggering $46 billion, making the budget deficit markedly worse that Greece's was before it was forced to seek a bailout. In comments to the press Tuesday, a senior analyst from the Fitch rating agency also raised fresh doubts about Ireland's rating.

At the same time, the Irish economic recovery fell apart in the second quarter, diving 5 percent at an annualized rate. The drop is fueling worries that the nation might be heading into another deep recession after its economy shrank by a whopping 10 percent in 2009.

Irish officials have rejected speculation the nation might need an IMF/E.U. bailout. On Thursday officials there are set to outline the cost of the Irish bank rescue. If those costs exceed current estimates, however, analysts say it could spark a full-blown crisis in Dublin. Adding to the government's woes, the opposition Fine Gael party announced this week that it would try to force snap elections and oust the administration of unpopular Prime Minister Brian Cowen.

"Many thought Ireland was on the right path, but if they don't stop this market panic soon, it is going to be a real problem," said Sonia Pangusion, senior economist for IHS Global Insight in London. "The bigger effect will come from the euro, since all this could put new downward pressure on it."

But the problems with Ireland and Portugal might not generate the same kind of upset seen when Greece reached a tipping point. During the first half of the year, global financial markets convulsed as the Greek debt crisis raised doubts about the ability of overextended nations in Europe to meet their obligations to investors, who lent them hundreds of billions of dollars by buying their bonds. The measure triggered a wave of government cutbacks from Greece to Spain, sparking a number of protests, with the most violent demonstrations on the streets of Athens.

The European Union has since established a $1 trillion bailout fund for countries in fiscal crisis, though just how willing other European nations will be to offer up those funds remains in question.

In addition, during the height of Greece's problems last summer, panicked investors drove up borrowing costs for a number of financially overextended nations across the region. They demanded higher interest rates to buy the bonds of nations including those with large economies, such as Spain and Italy. But in recent months, investors have been differentiating more between nations, with pressure easing on Spain and Italy, even as it escalated in Ireland and Portugal.

Still, a worsening situation in Ireland or Portugal could yet reignite a stronger panic across Europe, particularly in Spain. A Moody's rating review that is concluding this week could downgrade the nation's coveted AAA rating on its debt. Such a move could trigger a fresh sell-off in Spanish bonds, and worsen the plight of Ireland and Portugal.

On Tuesday, the cost of insuring against a default leapt in Ireland, Portugal and Greece. But it also increased, albeit more moderately, in Italy and Spain.

"There is still a lot of uncertainty, and the market is responding to that risk," said Ioannis Sokos, bond analyst at BNP Paribas in London.

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