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The Euro sculpture in front of the headquarters of the European Central Bank in Frankfurt


The euro's nightmare seems to have ended, but Greece's is only getting started.

The approval Sunday of a €45-billion ($61.35-billion) loan package to Greece triggered a relief rally that pushed up the euro - the currency used by 16 European Union countries - by as much as 1.4 per cent against the U.S. dollar Monday.

The rise, the euro's biggest in seven months, came as investors took the view that Greece no longer risked going bust, at least in the near future. The country must roll over €17-billion of bonds in the next six weeks alone, a daunting prospect before the European Union came to the rescue, after months of dithering. The total amount to be borrowed this year will reach €50-billion.

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Greek bonds reflected the sentiment. Their prices rose sharply, pushing down the two-year yield to about 5.8 per cent from about 7.15 per cent late last week. The yield on the 10-year bonds dropped by more than half a percentage point. The cost of insuring Greek debt against default also fell substantially.

Greece has not yet asked for the loans and the details of the emergency rescue package were still not known yesterday. Investors don't know what event would start the loans flowing, under what conditions they could be withdrawn or whether the individual EU countries need parliamentary approval to contribute to the package. The EU has offered €30-billion in three-year loans, at a below-market interest rate of about 5 per cent. The International Monetary Fund will contribute as much as €15-billion.

George Papandreou, Greece's prime minister, told reporters that the loans "send a clear message that nobody can play with our common currency and our common fate."

While the loan package boosted the markets, economists and strategists were under no illusion that the Greek debt crisis - or the pressure on the euro - had ended for good. The euro's gains may be short-lived, according to Derek Halpenny, the European head of currency research at Bank of Tokyo-Mitsubishi UFJ. In a note, he said "the financial package does not change the medium-term outlook, which is that the euro is likely to underperform other developed economies. That is set to keep the euro on a downward trend through the remainder of 2010."

Nomura International has a similar view. It sees the euro declining to $1.30 (U.S.) by the third quarter. The euro was trading at about $1.36 yesterday.

The threat to the euro is poor growth in the Euro zone, as austerity programs are launched to reduce bloated deficits and slow down or eliminate the rise in debt-to-GDP ratios. The debt problems are particularly severe in Portugal, Italy, Ireland and Spain - along with Greece, the so-called PIIGS. Britain, which is a member of the EU but not of the euro zone, also has enormous debt problems.

Greece will have to make some brutal sacrifices as it tries to put its fiscal house in order, due to the conditions imposed by the EU countries that will supply the loans. Spending must come down in a hurry to rein in the EU's biggest budget deficit. Greece last week raised its estimate for the 2009 deficit to 12.9 per cent of GDP, up from 12.7 per cent. The country's goal is to reduce the deficit by 4 percentage points this year. By 2012, it plans to have a 3 per cent deficit, the limit set by the EU's stability and growth pact.

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But economists think Greece will have a hard time reaching that number, all the more so because the austerity programs already announced triggered waves of protests in Athens earlier this year, and could do so again. That raises the question whether Mr. Papandreou's socialist government has the political will to slash government spending, raise average retirement ages, boost taxes and hunt down tax evaders.

A team of UBS economists led by Stéphane Deo, in London, said the Greek austerity program, which will be monitored and enforced by the IMF, would "create a massive GDP contraction."

UBS expects Greek GDP to fall 5 per cent this year, after a fall of 2 per cent last year. "In total, a number in the 10-15 per cent range seems a plausible guess for the cumulated Greek GDP contraction," the economists said in a note.

The market's confidence in Greece's austerity measures will be tested again Tuesday, when it will try to auction €1.2-billion in short-term treasury bills.

The big test will come on April 22, when it must roll over an €8.2-billion, 5-year bond.

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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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