It’s only one week since European leaders gathered in Brussels for yet another summit aimed at quelling the region’s spiralling debt crisis, and financial markets are once again in the grip of an agonising uncertainty.
Investors are growing sceptical about the solution trumpeted by German Chancellor Angela Merkel and French President Nicolas Sarkozy – a new treaty which will lead to closer economic integration and tougher budget discipline among eurozone members.
As a result, the market rout is gathering force. In countries such as Spain, Italy and Ireland, savers are racing to pull their money out of local banks, and are transferring their funds to countries such as Switzerland that boast a stable banking system. European banks continue to be wary of lending to each other, and the rates that banks charge each other for short-term US dollar loans has shot up to the highest level since mid-2009.
Overnight, the head of the International Monetary Fund, Christine Lagarde, warned that the global economic outlook was now "quite gloomy”.
"There is no economy in the world, whether low-income countries, emerging markets, middle-income countries or super-advanced economies that will be immune to the crisis that we see not only unfolding but escalating," she warned.
Most market observers share this grim prognosis. They argue that the debt crisis will continue to spiral unless European policymakers take two urgent decisions. In the first place, they need to boost the firepower of the eurozone’s emergency bailout fund. Secondly, the European Central Bank has to commit to buying up massive quantities of bonds of debt-laden eurozone countries.
But Europe is shying away from both. Overnight, the ECB’s new boss, Mario Draghi, told an audience in Berlin that the bank’s bond-buying was "neither eternal, nor infinite”, adding that it would take "a lot” more than monetary policy to restore market confidence in the eurozone.
Earlier this week, the powerful Bundesbank boss, Jens Weidmann, dismissed market calls for the ECB to start buying bonds, likening them to an alcoholic calling for a bottle. "I don't think it is sensible to give the alcoholic the bottle. He won't have an incentive to solve the problem”, he reportedly told journalists.
Instead, Weidmann claimed that the ECB’s enthusiasm for buying up the bonds of debt-laden eurozone countries was waning, and that advocates of the policy were becoming "increasingly sceptical”.
At the same time, plans for boosting the firepower of the eurozone’s permanent bailout fund, which is due to start operating next July, have also run into trouble. Overnight, Merkel ruled out increasing the size of the fund beyond the planned €500 billion ($US650 billion), even though most observers believe it needs to be twice this size if it is to be effective. What’s more, Berlin is pressing to have the €200 billion in emergency loans already granted to Greece, Ireland and Portugal to be deducted from the new fund’s resources.
At the same time, there are growing doubts about how many European countries will even ratify the new eurozone treaty. Under pressure from the opposition, the Irish Prime Minister, Enda Kenny, has not ruled out holding a referendum on the new treaty. The Netherlands, Sweden and Denmark could also struggle to get the new treaty ratified by their parliaments.
Meanwhile, the clock is ticking down. Investors are worried that negotiations between European officials and bankers over the Greek debt restructuring have stalled. Greece’s second bailout can’t be implemented until an agreement is reached on rescheduling Greece’s debts.
In addition, Italy’s borrowing costs remain stubbornly high. Yields on 10-year Italian bonds are now trading at 6.5 per cent, not far from the crisis level of 7.25 per cent they hit in late November. Investors are acutely conscious that Italy needs to borrow heavily from markets next year. Between February and April next year, Rome needs to find €91 billion to refinance maturing debt.
And that will be the ultimate test of the market’s faith in the Merkozy solution.