German Chancellor Angela MerkelFABRIZIO BENSCH/Reuters
Germany is continuing to resist the idea of throwing more money at the euro-zone debt crisis even as bond vigilantes set their sights on France, the region's No. 2 economy.
Spain, Italy and now France are all facing sharply higher borrowing costs as sovereign bond yields soared Tuesday across Europe.
France still retains its coveted triple-A credit rating, but investors are treating its bonds as if they are much riskier.
"The next shoe to drop in this debt crisis, now that it has spread to its core, is France's triple-A rating," David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates Inc., warned in a research note.
The risk premium on French 10-year bonds compared with German bonds is now just shy of 160 basis points – 3.5 per cent versus 1.9 per cent. That's near a two-decade high gap of 200 basis points.
A French downgrade would jeopardize a $1.4-trillion (U.S.) European rescue plan, worked out at an all-night leaders' summit in late October.
Credit conditions have continued to worsen in the weeks since. But not German Chancellor Angela Merkel's resolve to stick with the original plan, in spite of calls from France and elsewhere to do more.
"We don't have any new bazookas to pull out of the bag," Michael Meister, a spokesman for Ms. Merkel's Christian Democratic party, said Tuesday, borrowing a phrase coined by former U.S. Treasury secretary Hank Paulson.
"We see no alternative to the policy we are following," Mr. Meister said, adding that euro members must make it clear to investors that they're "ready to defend the currency."
Echoing that sentiment, Ms. Merkel said the region's debt crisis "can't be solved in a big bang."
"You can't restore this confidence with purely financial means," she added. "Only a coherent political response can create this confidence."
Among other things, France would like the European Central Bank to take on a more important role as the euro zone's lender of last resort.
French President Nicolas Sarkozy said he will soon be pitching proposals to Ms. Merkel that would promote greater economic and fiscal convergence among the 17 euro-zone countries.
Germany, on the other hand, is calling for stronger enforcement of the long-ignored debt and deficit rules in the euro zone. Ms. Merkel has also rebuffed calls to issue euro-area bonds.
These and other issues are expected to be on the table at a European Union summit on Dec. 9.
In a bid to keep borrowing costs down, the ECB has been buying up European sovereign bonds in recent weeks. But it hasn't kept yields in check.
"Europe remains the bad news that won't go away," said Toronto-Dominion Bank chief economist Craig Alexander.
In Spain, which is now paying nearly 7 per cent on 10-year bonds, the deputy leader of the newly elected People's Party called for a European rescue of the country from its crushing debt. Maria Dolores de Cospedal called for a deal to "save and guarantee the solvency" of Spain's $880-billion debt.