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German stand against euro bond sets stage for tense EU summit

Traders work at their desks in front of the DAX board at the Frankfurt stock exchange on May 22, 2012.

KIRILL IORDANSKY/REUTERS

Germany's near-term borrowing costs fell to zero as euro zone turmoil ahead of a European Union summit reinforced the country's status as the safest of havens.

The informal leaders summit, to be held in Brussels Wednesday, is unlikely to relieve the pressure on the bonds of the weakest countries. That's because various German officials have made it clear Germany will not endorse euro bonds at the summit, despite strong pressure to do so.

Italy, France, the European Commission, the International Monetary Fund and the Organization for Economic Co-operation and Development have all pushed for euro bonds in the days before the summit. Such bonds would be backed by the credit ratings of all 17 euro zone countries, effectively exploiting Germany's triple-A rating.

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The co-mingling of debt would substantially lower the debt costs of the weakest countries, and raise costs for the strongest. If Germany's borrowing costs were to rise to the euro zone average, its repayments would rise by about €50-billion ($64.7-billion) a year.

German Chancellor Angela Merkel has warned repeatedly that euro bonds would remove the weak countries' incentive to clean up their fiscal act. German Finance Minister Wolfgang Schaeuble has stressed that the basis for economic growth lies in fiscal discipline through austerity, combined with close oversight of euro zone budgets. "Fiscal consolidation is the precondition for our goal, which is more growth," he said this week.

Germany's opposition to euro bonds is bound to make Wednesday's summit tense. Frances's new president, François Hollande, had made euro bonds, along with fresh growth policies to counteract the job-killing austerity programs, the centrepieces of his euro zone rescue plan.

In a note Tuesday, economist James Nixon of France's Société Générale SA said, "Despite the smiles and show of unity, the respective positions of the two sides still look to be virtually immiscible. What is clear is the euro bonds will not be a white knight that rides to the rescue of the euro area's immediate travails."

The absence of euro bonds is likely to keep Germany's borrowing costs at rock-bottom levels. The yields of the distressed countries, including Spain and Italy, will likely remain high as confidence in their economic salvation plans collapse.

Germany's central bank, the Bundesbank, announced that it expects on Wednesday to sell two-year treasury notes that carry a zero-per-cent coupon. After factoring in inflation, that means bond investors are effectively paying the German government to protect their capital.

Yields across the German debt spectrum have plunged as sovereign bond investors dump the ailing debt of Greece, Spain, Italy and other euro zone countries mired in recession with little prospect of quick recovery. German 10-year bonds now yield less than 1.5 per cent, well lower than yields on U.S. and British debt. Only Japanese bonds, with a yield of about 0.85 per cent, are cheaper.

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Berlin plans to sell €5-billion of the two-year, zero-coupon debt. In mid-April, it sold a similar issue with a 0.25-per-cent coupon, and Germany also plans to sell €1.5-billion of inflation-linked bonds, maturing in 2023, with a yield that is likely to fall into negative territory.

Economists and strategists said that sovereign bond investors are more concerned about return of capital than return on capital as the debt crisis, after a brief interlude earlier this year, gains momentum. Greece's exodus from the euro zone is no longer unthinkable.

With euro bonds off the table at Wednesday's summit, growth measures are expected to rise to the forefront of the agenda. The leaders probably will endorse a €10-billion increase in the capital of the European Investment Bank, which finances infrastructure projects.

They will probably also call for greater use of EU structural funds in the countries with the highest jobless rates. Reportedly, about €80-billion of structural funds are available but unspent.

The leaders may also discuss granting the European Stability Mechanism, Europe's permanent rescue fund, which is to launch later this year, the ability to lend directly to banks. Currently, it is allowed only to lend to governments.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More

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