Irish bonds sink lower as Europe's debt fears grow

DUBLIN -- Anxiety over heavy government debts in Europe has flared up again as investors questioned whether Ireland, Greece and Portugal can cut their budget deficits without choking off desperately needed economic growth.

Markets were increasingly betting Wednesday that Ireland might be next in line for a massive financial bailout from its partners in the euro currency, after Greece's rescue from the brink of bankruptcy in May.

The interest rate, or yield, on Ireland's 10-year bonds jumped above 8 percent for the first time since the euro was introduced in 1999, reaching 8.64 percent in afternoon trading. Portugal managed to raise $1.74 billion in a bond auction, but at significantly higher interest costs than two months ago.

The fall in Irish bonds was accompanied by an announcement from London-based LCH. Clearnet Group, the world's second-largest bond clearing house, that it is significantly increasing the cash deposits it requires from traders dealing in those bonds.

The concerns over Irish debt follow European Commissioner Olli Rehn's visit this week to Dublin in an effort to convince opposition lawmakers to support Irish government plans to slash 15 billion euro from deficits over the coming four years through cuts and tax increases.

As the commissioner for economic and monetary affairs, Rehn is in charge of making sure that debts and deficits of the 16 euro-zone nations don't spiral out of control. Together with euro-zone governments, he also would have to sign off on any Irish request to tap Europe's 750 billion euro emergency fund -- a possibility that Ireland dismisses but investors consider increasingly likely.

But current market concerns go beyond governments' immediate ability to slash their budget deficits. More and more analysts are wondering how Ireland and Portugal, in particular, can get their economies growing fast enough to pay off their debts.

"The focus is now shifting from fiscal consolidation towards economic growth," said Carsten Brzeski, chief economist for ING in Brussels.

Europe's most indebted countries find themselves in a downward spiral of budget cuts and economic stagnation.

Ireland's debt is expected to reach 98.6 percent of gross domestic product this year, while Portugal will face a debt pile of 83.3 percent of economic output.

Greece's debt level depends on the revised figures for its 2009 deficit, which are due to be released next week. Most economists expect Greek debt to reach 120 percent of GDP by the end of the year.

To keep their debts from surging further, governments are slashing spending, laying off public-sector workers and raising taxes -- all actions likely to dampen economic growth.

A stagnating or shrinking economy reduces tax receipts and makes it almost impossible for governments to produce the substantial budget surpluses needed to chip away at their debt -- completing a vicious circle. "It's very hard to get out of there," Brzeski said.

In the second quarter Ireland's GDP fell 1.2 percent and Greece's 1.8 percent, while Portugal hobbled along with 0.3 percent growth. The European Union statistics agency's first estimate of third-quarter GDP this Friday may be a harbinger of more pain.

A decision by EU governments last month to create a mechanism that would force private investors to bear some of the pain the next time a euro-zone government runs out of money is creating more market jitters.

Rehn's team at the European Commission is supposed to come up with a plan by December for how such a mechanism would work. But for now there is "complete uncertainty over what the mechanism will look like," said Daniel Gros, director of the Brussels-based Center for European Policy.

Investors are worried about losing part of their money if a nation defaults on its debts, even though the current proposals would permit such defaults only on debt issued once the mechanism is in force -- most likely not before 2013.

In that scenario "it will not be possible to involve private creditors until 2025," when many bonds would mature, Gros said, adding that some EU members found the suggestion of such a long delay "difficult to swallow."

Requesting money from the European stability fund would buy governments more time and lower funding costs. But it wouldn't significantly reduce the size of their long-term debts, leaving them in a precarious situation when the facility expires in 2013.

Irish Prime Minister Brian Cowen insists his country has enough cash on hand to fund the government budget through June 2011.

But if yields remain at their current levels until then, he might have no choice but to ask for help from the European stability fund -- a process that is likely to take up to six weeks.

What will happen to Irish, Portuguese and Greek debt once emergency funding runs out on June 30, 2013, remains up in the air. Even if a European crisis resolution mechanism would allow for an orderly default on new bonds, uncertainty over how to deal with the debts will likely rattle markets for years to come.

"The question is what then happens in reality," Gros said. "Everything is now possible."

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Steinhauser reported from Brussels.