Harbour Commentary: Holes in the lifeboat

• The European sovereign debt crisis has dominated financial markets again this month.
• At the end of October, the market took a huge sigh of relief when European leaders announced their latest rescue package.
• However, the plan lacks key details and faces significant implementation challenges, including a possible Greek referendum.
• Italy and Spain, in particular, face the greatest threat of contagion if the crisis spreads.
• It will be some time before concerns about Europe subside for good.
• In the meantime, Europe looks set to be a drag on global growth, helping to underpin the relatively low level of interest rates in core developed markets like New Zealand.

The European sovereign debt crisis remained the main driver of global fixed income markets during the course of October, continuing the theme that dominated markets over September. After experiencing the depths of pessimism following the IMF/G20 meetings in September, there was a strong sense of anticipation over the first half of October as optimism grew that European policy makers had grasped the severity of the crisis and would deliver a comprehensive rescue package.

The Lifeboat has arrived!

There was a huge sigh of relief from markets when a rescue package was announced on 27 October, after European leaders worked into the small hours of the morning to finalise the deal. And there were certainly plenty of positive elements to cheer about.

• European leaders had set aside their internal squabbles and met their self-imposed deadline ahead of the November G20 summit.
• The larger haircut on Greek debt of 50% was a step in the right direction to put it on a sounder footing. And the two largest vulnerable European countries, Spain and Italy, committed to improving their debt positions through structural reforms.
• The firepower of the European Financial Stability Facility was increased from Euro 440 billion to Euro 1 trillion providing more resources to address the crisis. And importantly, bringing the IMF and other countries like China into the rescue fund acknowledged the size of the problem - it is a global problem - that requires a global solution.
• Finally, there was a plan for recapitalising banks to the order of Euro 109bn, detailed down to individual banks. It highlighted that those banks that needed to raise capital were largely contained to Greece, Italy and Spain - with less needed in France than expected, and UK banks requiring no more capital.

Holes in the Lifeboat