Sovereign debt: ECB must keep liquidity pumping
Governor Trichet must play it safe as markets fret about sovereign debt.
We all know the saying "you made your bed, now you must lie in it". That’s what faces the European Union as it seeks a solution to the potential financial meltdown being generated by Greece’s fiscal crisis, which threatens to envelope its EU’s neighbours.
The EU’s inability to police its profligate member states in a situation where budget deficits have made a joke of the 3% of GDP ceiling, while incentivizing the banking system to invest in government debt that is anything but risk free, has placed the EU and its central bank in an awkward position. The event risk pertaining to the access to bond markets for southern European sovereigns has the potential to damage the fragile recovery within the banking sector, by propagating a repricing of risk. European banks, particularly in the south, are facing sharply higher funding costs and significant markdowns on the asset portfolios all at a time when they need to increase term funding. This threatens a recovery in the institutional loan markets and could limit access to the capital markets for high-yield bond issuers barely a year after they reopened for business.
This is not a time for the European Central Bank to begin its withdrawal of special liquidity programmes, which it says it has already begun to do.