Euro falls amid stress-test anxiety

Analysts expect between five and 15 European banks to fail stress tests as Italy prepares to vote on austerity budget European stock markets opened lower and the euro fell on Friday morning amid anxiety about the outcome of the stress tests on European banks, which will end a tumultuous week for the eurozone. Spain’s Ibex was down 0.4% while Italy’s FTSE MIB opened 0.5% lower. In London, the FTSE 100 index dropped 26 points in early trading to 5820, a fall of 0.4%. Germany’s Dax traded 0.4% lower while France’s CAC lost 0.5%. The euro briefly hit a one-month low against the pound, falling to 87.475p, the lowest since 16 June. The annual healthcheck on 90 European banks will be announced after the markets close on Friday, at 5pm London time. Up to six Spanish banks are expected to fail along with several Greek banks. Analysts polled by Reuters expect between five and 15 banks overall to fail. “What a great end to a turbulent week,” said Gary Jenkins, head of fixed income research at Evolution Securities. “The sovereign crisis may overshadow the actual results of the tests, but the market will look closely at disclosures on peripheral exposures and draw its own conclusions from those.” The lower house of Italy’s parliament is expected to vote through austerity plans worth €48bn. “European asset price volatility continues and whether it calms down will depend a lot on what happens to Italy,” said Paul Robinson at Barclays Capital. “Italian developments have been particularly important over the past week and are likely to remain at the centre of attention ahead of the publication of the stress tests today and vote in the camera (lower house of parliament) on the austerity measures. “There is little to suggest that Italian banks will emerge from the stress tests needing a large injection of capital. But a large stock of government debt means that Italy is vulnerable.” Italy is forecast to have a debt-to-GDP ratio of 120% this year, while that for Spain is seen at 70%. Amid growing concern that Europe’s policymakers have allowed the debt crisis to spread to the major economies of monetary union, the healthcheck announcement will provide details of the exposure of individual banks to debt writedowns or defaults. While UK banks are expected to pass the stress tests, there are fears the tests will show some banks in Europe have insufficient capital to cope with bad debts. Although the tests have been toughened since last year, they do not include the possibility of a Greek default, seen as increasingly likely by the markets. Italy had to pay record interest rates of 5.9% to persuade investors to buy its bonds on Thursday, while borrowing costs for Spain also rose. Estimates of how many banks will need extra capital range from nearly a third of the 90, according to the ratings agency Moody’s, to nine needing €29bn, according to the average opinion in a poll of investors by Goldman Sachs last month. Marie Diron, senior economic adviser to the Ernst & Young eurozone forecast, said: “The stress tests are unlikely to bring much relief to the current tensions that plague the eurozone. They will probably show a small minority of banks failing, mainly in the eurozone periphery, with possibly a few in core eurozone countries failing, too. But the credibility of the stress tests has been undermined by what is perceived to be too lenient assumptions.” The tests, discredited last year when Ireland’s banks collapsed four months after being given a clean bill of health by the regulators, are already causing controversy. The number of banks was originally 91, but German bank Helaba pulled out on Wednesday in a dispute with the European Banking Authority, which is overseeing tests by domestic regulators, and will announce its results separately. The UK’s banks, two of which have been bailed out, are believed to have passed. The head of the European parliament’s economic and monetary policy committee, Sharon Bowles, will say on Friday that German banks were manipulating the results of tests which show they are in urgent need of recapitalisation: “In their latest round of crisis denial, German banks are lining up to try and hide what any decent analyst already knows, that there are significant cases of undercapitalisation.” The tests are carried out by national regulators across Europe but compiled by the European authority, which requires banks’ core tier one capital to remain above 5% after worst-case scenarios, which include a drop in GDP over two years of 4%, compared with 3% for last year’s tests. Tamara Burnell of M&G Investments said: “It is like taking a driving test: you can pass and yet be a terrible driver. The real test is whether people are prepared to get in the car with you. So whether or not banks pass the 5% hurdle, the real test is whether investors and depositors trust them with money over the long term. And there’s a long way to go before the European banks rebuild their reputation after a series of offences.” While an outright default by a European nation is not included in the test (despite officials now being prepared for a Greek default), Christopher Wheeler, analyst at Mediobanca, notes that only 20% of the government bonds held by banks are being stress tested, because they sit in their trading books, rather than the banking books where bonds are held to maturity. Making assumptions about the “haircuts” (losses on government bonds across Europe), Mediobanca estimates €81bn could be knocked off banks’ capital, 9% of the sector, in 2012. It is not just banks’ holdings of government bonds that are important, but also the way governments have stepped in to support banks, making their healths inextricably linked. Burnell said: “What we need to test is the ability of sovereigns to separate themselves from their banks.” European debt crisis Banking Euro European Union Economics Europe Italy Europe Julia Kollewe Jill Treanor guardian.co.uk

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