Europe: Tough Bond Auctions To Test Confidence, Future

Could this be the crucial week for the euro, the eurozone and financial stability in Europe and the rest of the global economy?

Italy, Spain, France and Belgium will each attempt to borrow billions of euros through a string of debt auctions in the face of growing reluctance by investors to hold even the safest European debt.

Belgium, Italy, Spain and France are on course to issue up to 19.5 billion euros ($US26 billion) in nominal and index-linked bonds next week, as well as another €9 billion to €9.5 billion in short term bills, according to analysts.

After the surge in yields on Italian debt to more than 8% on Friday, Belgium's downgrade and the jump in German yields after the failure of a 10 year bond auction last Wednesday, the sales will be a huge test of confidence.

"After the recent hiccups in the primary market arena, all auctions have to be regarded as 'event risks,'" wrote strategists at Commerzbank last week.

An "event risk" is something with the capacity hit confidence and market activity hard, as that failed German bond auction last Wednesday did.

On Friday we saw a small market 'hit' when Italy was forced to pay a record 6.5% for six months bills on Friday.

And yields at the 2, 5 and 10-year levels soaring above 7% as a result.

Yields on two year bonds jumped past 8% in the secondary market on Friday, meaning the Italian yield curve has inverted even more dramatically.

(An inverted yield curve is where short term yields are above longer term rates and signal the rising prospect of a recession.)

Germany's 10-year bond yield ended the week at 2.26%, up from around 1.96% last Friday.

The failed 10 year bond sale on Wednesday saw rates rise as investors sold German debt.

The euro had a sharp fall which closed at $US1.3281 and was down nearly 2% for the week.

Italy is set to sell €500 million to €750 million of index-linked bonds tonight, our time, and tomorrow night we will see it try to sell between €5 billion and €8 billion of bonds, including a new three-year benchmark 10-year bond and a 2020 bond.

"The indicated range is sizeable and above our expectations," RBC analysts wrote.

"We expect the upper end of this range to be out of reach in the current market environment."

Belgium will tonight try and sell €1 billion to €2 billion of 2018 bonds as well as its 10-year benchmark and other issues. Belgium will have to pay more after Friday's downgrade to an AA credit rating.

Worries about the bailout of broken bank Dexia SA and the continuing failure to agree on a new government caused the downgrade and sent the yield on Belgium's 10-year bond above 5.8% last week.

But in one tiny bit of good news, Belgium's warring political factions (Flemmings v Walloons) reached a deal to reduce the leaderless country's budget deficit, bringing it closer to forming a government after 531 days of post-election drift.

The agreement came after the country's credit rating was cut by Standard & Poor's, so there was at least one positive from a ratings downgrade.

Spain is expected to try and sell €3 billion to €4 billion in various bonds on Thursday, while France is set to auction up to €4.5 billion of bonds on the same day.

Spain's chances will be complicated by reports (later strongly denied) that the new conservative government was looking at asking Europe for some sort of official help to stabilise its position.

Tuesday sees a meeting of the 17-member Eurogroup of finance ministers in Brussels.

Just what they can now do to halt the slide is problematic. Everything they have tried in the past has failed.

The economies of the eurozone and outsiders such as the UK are sliding towards recession and the financial system is freezing over.

In London it will be gloom and doom all week.

The mid term budget review this week is being overshadowed by the realisation the economy is on its way to a recession.

London media reported at the weekend that the Organisation for Economic Development and Cooperation (OECD) is predicting that the economy will shrink over the first half of 2012.

The prediction, to be published tonight Sydney time, by the OECD Monday, will be followed by the mid term review from the government, new forecast from the independent Budget office and then the latest financial stability report from the Bank of England on Thursday, all of which will paint the outlook for the UK in a very gloomy light.