Fear gripped markets this week as the euro crisis worsened. Greece is set for fresh elections next month as it failed to form a government following last week’s vote. With the anti-austerity faction likely to get even stronger, a Greek default and euro exit is now being openly discussed.
There are now fears that bank runs could occur. Customers rattled by the prospect of a new, devalued currency and the turmoil resulting from a Greek euro exit, or ‘Grexit’, have been steadily withdrawing their cash. The euro slumped to a three-year low against sterling. Spanish ten-year bond yields jumped to a seven-month high amid worries over Spain’s banks.
What the commentators said
The Greeks “have lost their stomach for austerity”, said Hugo Dixon on Breakingviews. And “the rest of the eurozone has lost patience with Athens’ broken promises”. If Greece turns its back on the rescue package, it will have little option but to exit. It would soon run out of money to pay public servants and the banks would no longer be propped up by the rest of the eurozone. But the return to the drachma could have “devastating” knock-on effects unless the eurozone is well prepared.
One potential outcome is a chain of bank runs as people in other peripheral countries, fearing defaults, move their money to the core, causing a collapse of banking systems. Markets would also send bond yields sky-high, making it all the more difficult for the likes of Italy and Spain to finance their borrowing.
“Everything hangs on what actions policymakers are willing and able to take” to prevent contagion, said Capital Economics. One problem, however, is that the ‘firewall’ – the money in Europe’s beefed-up rescue fund – isn’t nearly enough to cover Spain and Italy’s debt, and thus convince panicked investors that they would get their money back. So the European Central Bank would have to be prepared to buy limitless quantities of bonds to calm markets, said Dixon, and would have to provide unlimited funds to banks too to stop the tide of withdrawals.