In Europe, Anxious Market Shifts Focus To Italy

Among fresh warning signs, Italy’s cost of borrowing has jumped to the highest rate since the country adopted the euro. Others signs include pressures building in the plumbing of Europe’s banking system. While those pressures are not yet at the levels experienced during the 2008 financial crisis, when some markets in the United States froze altogether, they are high enough to cause worry, analysts say.

Even as Greece reached an agreement on Sunday to form a coalition government meant to avert the collapse of the latest bailout plan for the euro zone, investors are still demanding greater certainty on how Europe would pay for a rescue package aimed at stopping the Greek financial contagion from spreading to Italy or Spain.

“This is a bit of a sideshow,” Mark D. Luschini, chief strategist at Janney Montgomery Scott, said of the shifting political leadership in Greece. “Markets will react favorably to this, but they won’t rally hard on the news. Italy is the bigger issue.”

In the United States, credit markets tightened earlier this year during a political stand-off over the debt ceiling and the ratings downgrade of the country’s long-term debt by Standard Poor’s, but conditions have eased since then.

European banks are likely to remain wary about lending to one another, analysts predict, and investors will continue to require high interest rates on the billions of euros in loans Italy needs each month to keep its economy afloat.

The yield on 10-year Italian notes has surpassed that on Spanish debt, reaching 6.35 percent on Friday after leaders at a meeting of the Group of 20 nations failed to come up with details on how to stop the European crisis from spreading. The rising yield is troubling because once the interest rates on the debt of the bailed out countries Greece and Portugal surpassed 7 percent they shot up far higher, requiring those countries to turn to outside sources of financing. Rates on their debt remain in double digits.

At the end of last month, Italy issued 3 billion euros worth of bonds at an interest rate of more than 6 percent, about 1.5 percentage points higher than it had had to pay as recently as the summer. The extra bond yields are adding as much as 3 billion euros (about $4.1 billion ) annually in additional interest payments, estimates Tobias Blattner, a former economist at the European Central Bank who is an economist at Daiwa Securities in London.

Analysts are concerned that if interest rates on Italian debt keep rising, the country may no longer be able to afford to borrow on the open markets and instead would have to turn to official lenders like the European Union or the International Monetary Fund.

The latest rate “is a warning,” said Mark McCormick, currency strategist at Brown Brothers Harriman. “Seven percent would be a point of no return.”

The European Central Bank is providing another gauge of European stress — the amount of sovereign bonds it is now buying on an almost daily basis. The central bank is trying to provide a market for the debt of countries like Italy and keep interest rates from rising to punishing levels.

This year, the amount of sovereign debt held by the central bank has more than doubled, to over 150 billion euros. Many analysts say they think the bank would have to buy bonds on a much larger scale to stop interest rates from creeping higher, let alone drive yields substantially lower.

 European banks, worried about each others’ exposure to bad debts, have demanded an increasingly higher interest rate to lend euros to one another. The rate, measured by a gauge called Euribor-OIS, was 20 basis points as recently as June, but has since jumped to 90 to 100 basis points. (A basis point is one-hundredth of a percentage point.) The current rate, however, is still far below levels in 2008 and 2009 during the financial crisis, when it reached more than 2 percent.

 Since May, sources of dollars have also been drying up, as United States money market funds have pulled back from buying the short-term debt of European banks.

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