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Irish debt concerns rattle markets

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Ireland's borrowing costs hit a record high on Tuesday after two credit rating agencies warned its debt is at risk of further downgrades, compounding political jitters over a budget that could break a shaky government.

Ireland is battling to convince investors it can afford to rescue its stricken banking sector and cut the biggest budget deficit in the European Union, given a weak economy and growing risks of a political crisis.

"I cannot pretend that the current rating is totally secure," Chris Pryce, a senior analyst with Fitch, which has Ireland at AA- with a stable outlook, told Reuters.

Dublin is hoping a final bill for dealing with nationalized lender Anglo Irish Bank, expected later this week, will clear up fears that the cost will vastly exceed a current estimate of 25 billion euros ($34 billion US).

"We will be ... providing a manageable way forward on how that will be dealt with over the longer term," Prime Minister Brian Cowen told reporters.

His coalition's parliamentary majority may have shrunk to two seats after defections, the opposition is upping pressure for an early election, and his Green partners look increasingly uncomfortable in government as harsher austerity measures loom.

"We are determined to do what's necessary to achieve international confidence and build domestic confidence," Cowen said.

Asked whether Dublin might have to resort to the euro zone's rescue fund, he said Ireland had already raised enough funds to meet its needs into the middle of next year.

In Brussels, a European Commission spokesman said emergency funding for Ireland was not under consideration and a senior euro zone source said Dublin had not even held any informal talks on using the safety net.

Standard & Poor's, in a Sept. 14 interview broadcast on Ireland's state broadcaster on Tuesday, said its 35 billion euro estimate for Anglo, a figure heavily criticized by policymakers, looked increasingly realistic and any amount beyond that could trigger rating downgrades.

The ratings agencies' warnings, including Moody's decision on Monday to slash its ratings on Anglo Irish's lower-grade debt, sent Irish sovereign spreads and the cost of insuring Irish debt against default to record highs.

The news also drove the premiums on bonds from other economies on the euro zone periphery to new highs.

The premium investors demand to hold 10-year Irish government bonds rather than benchmark German bunds hit a euro lifetime high of 475 basis points, meaning it costs Dublin some 4.75 percentage points more than Berlin to borrow funds.

The cost of insuring Irish sovereign debt against default soared to a record 519 bps from 488.5 at Monday's New York close, according to data monitor CMA.

Ireland's credit rating currently stands at AA- with S&P and Fitch -- seven notches above junk grade -- and Aa2 with Moody's -- 8 above junk.

The OECD's chief economist told Reuters he did not see Ireland heading towards a Greek-style crisis.

Some analysts have said Cowen needs to speed up the budget announcement to convince markets of how the government will find more than an extra 3 billion euros in savings.

"The costs are rising because of policy inaction on behalf of the incumbent government," said Ciaran O'Hagan, bond strategist with Societe Generale.

"The French budget is being published tomorrow, the Irish budget is being published in December. They are going to give a pre-budget statement in the second half of October, that's a month away."

Cowen, who recently shook off calls to resign after allegations of a boozy night out, was blasted by Irish tabloids on Tuesday after U.S. talk show host Jay Leno ridiculed him as a "drunken moron."

ONE MORE SHOT?

Foreign Minister Micheal Martin insisted the government would see out its term until 2012 despite the turmoil.

"We're satisfied that we will go the full distance," Martin told Bloomberg TV.

"Obviously in this economic turbulent period, you will have rocky rides and issues will arise but we are very, very determined to see this through for the benefit of the country."

Fitch's Pryce said the government's wafer-thin majority was a worry but Cowen still had time to reassure investors.

"Further downgrades may be avoided," Pryce said. "The Irish government has at least one more shot in its bow."

But O'Hagan said the credibility of the Anglo bill was dependent on the outlook for the Irish housing market, where prices are in some cases half their peak and still falling.

"Even if the government does come out with a number, the only thing that will make it believable is if there is some sort of prospect of stability for the housing market."

The 25 billion euros of aid so far earmarked for Anglo Irish would already push Ireland's 2010 budget deficit to around 25 percent of gross domestic product, compared with an EU limit of 3 percent that Dublin aims to reach by 2014.

Dublin has said the budget blow-out is a one-off due to European accounting rules and the impact of the Anglo bill would be minimized by spreading the cost over at least a decade.

But investors remain unconvinced about the plan to wind down Anglo via a split into a "funding bank" and "asset recovery bank." Adding to the nervousness is the ending of a state guarantee on dated subordinated debt on Sept. 30. A guarantee on senior bonds worth 4.2 billion euros in Anglo Irish lapses as well.

Ratings agency Moody's downgraded Anglo Irish's unsecured senior debt on Monday, citing a small residual risk the government might not support this debt.

A Finance Ministry spokesman said on Tuesday Ireland will honour its obligations to senior bondholders.

Analysts expect the government to buy back Anglo's 2.4 billion euros in subordinated bonds at a discount. The paper has been trading at a discount of 70 percent-80 percent in the secondary market.

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