Markets seek direction in wake of G20 pledge, Greek coalition

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Investors took a modicum of cheer from the Group of 20's commitment to drive down the euro zone's borrowing costs and Greece's lurching, though apparently productive, efforts to form a coalition government with the strength to forge a new alliance with the country's paymasters.

The lukewarm enthusiasm, however, was tempered by another does of data that provided more evidence of slowing euro zone economies. In Britain, jobless claims unexpectedly rose in May, suggesting the labour-market recovery is running out of puff.

The G20's commitment to hammer down borrowing costs managed to halt the rise in the bond yields in Italy and Spain, the region's third- and fourth largest economies, both of which are considered too big to save should they get shut out of the debt markets. The yield on Spanish 10-year bonds fell six basis points, taking it to just under 7 per cent (100 basis points equals one percentage point), while the yield on equivalent Italian bonds fell three basis points.

Spanish yields near 7 per cent are considered unsustainable. Only a few months ago, they were about 5 per cent.

European markets rose Wednesday morning. In London, the FTSE-100 index was up about 0.20 per cent and the euro rose marginally to $1.27 (U.S.), after plunging earlier in the week.

The G20's communique, released Tuesday night in Mexico, did not specifically say how the borrowing costs would be tackled. But Italian prime minister Mario Monti, who is hosting a four-country summit in Rome on Friday, and his French counterpart, François Hollande, favour using Europe's bailout fund, the European Financial Stability Facility (EFSF), to buy sovereign bonds. It was given the power to do so last year, though the European Central Bank has been the only official buyer of the bonds of troubled countries, and so far in sparing amounts.

Clearly, Mr. Monti and Mr. Hollande have Spain and Italy in mind. Both countries are back in recession and their jobless rates are still climbing. Spain last week agreed to accept as much as €100-billion from the EU to recapitalize its struggling banks, which are heavily exposed to Europe's biggest property bust.

There were no assurances Wednesday that Germany would accept the idea of allowing the EFSF to buy Spanish and Italian bonds, though Berlin has hinted it is willing to be somewhat flexible.

As investors struggled to give the market some direction, Greece was coming close to forging a coalition four days after the general election that gave no party a majority. The coalition would be led by the centre-right New Democracy, headed by Antonis Samaras, the probable next prime minister, and include the socialist Pasok party and the small Democrat Left party.

Together, the trio would have 179 seats in the 300-seat parliament, though face strong opposition from Syriza, the radical left party that has surged in the polls and wants to scrap the bailout program that insists on harsh austerity measures. Syriza blames austerity for squeezing the life out of the Greek economy, and many economists and European politicians agree.

The new Greek government would seek to renegotiate the terms of the bailout, though Germany has made it clear it will not allow any significant dilution of the austerity measures. At minimum, Greece hopes to get a two-year extension on its medium-term spending cut commitments. It argues that another round of deep cuts now, when the economy is in deep recession, would cause enormous economic and social pain.

Greece wants a new government in place today so it can send a finance chief to Thursday's meeting of euro zone finance ministers in Luxembourg. That meeting is expected to kick-off a marathon round of negotiations aimed at bringing the euro zone closer together, such as creating a banking union. What the summit won't do, however, is bring an immediate cure to the crisis as Spain and Italy enter danger territory.