Europe’s bailout fund cannot meet Spanish and Italian funding costs, says L&G economist Tim Drayson.
Any attempts to significantly leverage the European Financial Stability Facility (EFSF) cannot be achieved without undermining the core eurozone sovereign bond markets, he warns.
“The risk of a disorderly outcome in the euro area has clearly increased and it appears that the Germans are willing to play brinkmanship to extract the maximum amount of reform”, says Drayson.
Drayson says this assessment is reinforced by the recent decision of Standard and Poor’s (S&P) to place 15 eurozone governments on downgrade alert and the absence of externally sourced capital for the fund.
S&P simultaneously made the decision to place the EFSF itself on a downgrade warning, following the sovereign warnings.
“Unconditional and unsterilised bond purchases” are the clearest path to stabilise asset prices, says Drayson, but such a response will probably only be triggered by a further deterioration of the situation.