Spain's government debt rallies and the euro recovers against the US dollar after Austria's central bank governor said Europe's permanent bailout fund should be given new powers
Optimism that eurozone leaders might take new steps to rescue the single currency helped to drag Spanish bond yields away from their record highs on Wednesday.
Spain's government debt rallied and the euro recovered against the US dollar after Austria's central bank governor, Ewald Nowotny, said Europe's permanent bailout fund should be given new powers to protect the euro, an apparent softening of his position.
Nowotny, who serves on the European Central Bank (ECB) council, said there were arguments in favour of giving the European Stability Mechanism (ESM) a banking licence. This would allow the ECM to leverage its balance sheet by borrowing from the ECB, dramatically increasing its firepower, a move that has been repeatedly opposed by the ECB itself in the past.
Spanish government bonds had initially fallen in value again this morning, as the country continued to be hit by fears that it might need a bailout. This sent its bond yields to new euro-era highs. At one stage the yield on its five-year bonds was higher than the 10-year, known as an 'inverted yield curve' – typically a sign that a deep recession is looming.
But by Wednesday afternoon, Nowotny's comments caused Spanish sovereign debt to gain in value. The yield on its 10-year bond was down 20 basis points – a significant move – at 7.46%. The euro rose by half a cent against the US dollar, to $1.212.
One reason for the recovery was a denial from Berlin that Germany has been pushing Spain to take a financial aid package worth at least €300bn (£234bn).
There was also relief in the City after the finance ministers of Spain and France called for a single eurozone banking regulator to be set up by the end of this year.
After meeting in Paris, Spain's Luis de Guindos and France's Pierre Moscovici issued a joint statement calling on European leaders to "swiftly" implement the plans agreed at the last EU summit at the end of June.
"Our common strategy for the stability of the euro area includes the adoption, by the end of this year, of a single supervisory mechanism for banks of the euro area, involving the ECB; we expect proposals by the Commission by September and commit to a swift negotiation. This supervisory mechanism will open the way for direct recapitalisations with appropriate conditionality," they said.
Once a pan-European banking supervisor has been created, it will be possible to directly recapitalise eurozone banks – strengthening their finances without adding to the debt burden of their national governments.
Despite the optimistic mood on Wednesday, economists warn that the euro crisis is still the biggest threat to the world economy.
Jim O'Neill, chairman at Goldman Sachs Asset Management, told CNBC that the currency union will shed at least one member by 2014 unless leaders rapidly strengthen fiscal union across the eurozone.
"Two years maximum is my perception of the time the euro zone has left to survive in its current form, though the reality is probably far less than that," said O'Neill, an outside candidate to be the next governor of the Bank of England.
Sebastien Galy, currency strategist at Société Générale, warned that the ESM was unlikely to be granted a banking licence, despite Nowotny's apparent change of heart.
"While it would be a game changer, the odds are this will be squashed once again by someone high on principles," Galy said.