European financial markets took another turn for the worse Monday, as the Greek government's announcement that it would miss its budget target made the prospect of a "hard" default more likely.
Greece needs to cut its deficit to 7.6% of gross domestic product this year to keep receiving aid from the International Monetary Fund, the European Union and the European Central Bank, but Athens Sunday confirmed that an unexpectedly harsh recession means the actual deficit will be closer to 8.5%.
Consequently, it will be harder for the IMF and EU to justify paying out the next €8 billion tranche of aid as scheduled in October. A growing number of countries, led by Germany, have said they would be reluctant to continue funding Greece if it keeps missing its targets.
Even so, many still believe the fear of financial chaos will outweigh any risk of moral hazard and keep Greece's drip feed going, at least for now.
"The austerity drive is large enough to illustrate that Greece still has an appetite to do what it takes to remain within EMU," said Padhraic Garvey, an analyst with ING in Amsterdam.
The euro fell around a third of a cent to $1.3364, and has now given up almost all of this year's gains against the dollar. Stock markets across the region also retreated, led by the banks that would be most affected if Athens can't pay its debts. By late morning, the DJ Stoxx 600 sub-index for banks was down 3.0%.
If the creditors pull the plug, then Europe's banks–above all Greek ones—could be sitting on over €50 billion of Greek government debt that would be effectively worthless until a restructuring agreement could be put in place. In that case, Moody's Investor Service said banks might need to write off up to 60% of their holdings—almost three times what they were supposed to write off under an agreement hammered out by euro-zone leaders in July.
That agreement looks increasingly outdated.
German government bond futures, the refuge of most European capital seeking safety, rose to 136.99, up 0.50 point from Friday's close. However, there were signs that fear had started to affect even bunds, as the cost of insuring against a German default also hit a record high.
The ECB again seemed to be the only entity preventing even greater disorder. Traders said it stepped in yet again to support the Italian and Spanish bond markets, while ECB data published early Monday showed that banks were more afraid of lending to each other than at any time for more than a year.
The ECB said banks placed €199.639 billion in its 0.75% deposit facility over the weekend, the most since July 2010 and up from €161.415 billion Thursday. Use of that facility rises when banks are wary of one another, and prefer to place their surplus liquidity in the safest place possible.
Market participants are hoping for more decisive intervention from the ECB at its governing council meeting Thursday, either in the form of longer refinancing tenders or even a cut in official interest rates.
read more: Olympus Wealth Management
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