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EU ready to help amid bond sell-off

ireland A man walks past two empty shops in Dublin, Ireland. Picture by AFP Source: AFP

THE EU said it is prepared to help Ireland as investors continued dumping bonds issued by Ireland and other fiscally weak euro-zone nations.

The euro continued to slide against the US dollar as investors grew increasingly anxious about fiscal challenges facing countries along the troubled edge of the 16-member euro zone.

The shared currency fell almost 0.9 per cent against the US dollar to $US1.3657 late in Europe trading, hitting a one-month low. Just one week earlier, the euro was trading at $US1.4216 after the Federal Reserve announced a new, $US600 billion ($601bn) round of bond purchases to drive down long-term interest rates.

"This was always the risk for the euro, that the focus would come back to the peripheries," said Daragh Maher, a currency analyst at Credit Agricole in London.

Ireland's struggle to rescue its banking system has driven its budget deficit to 32 per cent of gross domestic product, more than ten times the euro zone's deficit ceiling.

In recent days, investors have grown more doubtful that Ireland will succeed in reducing its deficit without external help.

Earlier this year, Greece required help from the European Union and International Monetary Fund to deal with its own fiscal crisis, sparking a selloff in the euro and raising questions about the currency union's long-term prospects.

The EU reiterated that it has the tools to deal with Ireland, should it need to. The EU earlier this year established a €440bn ($602bn) sovereign rescue fund, mainly in response to the Greece crisis.

"We have all the necessary instruments," European Commission president Jose Manuel Barroso told reporters in South Korea, where he was attending the summit of the Group of 20 industrialised and emerging nations.

"The EU is ready to support Ireland."

The risk of another euro-zone debt crisis continues to roil government bond markets along the EU's periphery, where some governments are struggling to reduce deep budget deficits without tumbling back into recession.

The cost of insuring debt against potential default using credit default swaps hit record highs for Irish, Spanish and Portuguese government bonds in European trading. These costs also rose for Greece, Italy and Belgium.

Also, the yield on Ireland's 10-year government bond, which moves inversely to its price, hit 9.24 per cent, a record 6.83 percentage points more than the rates on lower-risk German bunds. More troubling, the yield premium, or "spread," for Irish two-year bonds is also about 6.83 percentage points.

Normally, longer-dated government bonds offer a significantly higher yield, since investors lose more control over their cash when they lend it for longer periods. Spreads tend to equalise across durations ahead of defaults as investors reason that the time difference no longer matters if a borrower quickly proves unable to repay its debt.

Ireland, however, has enough cash on hand that it won't need to return to the bond market until the middle of 2011.

Portugal's fiscal situation is also grim. Its 10-year borrowing rate is 7.33 per cent, with a yield premium over 10-year bunds of 4.92 percentage points. Earlier this week, Portugal sold six- and 10-year bonds at the highest yields since the introduction of the euro.

Spanish and Italian spreads have also widened in the past month, but not as sharply.

The European Central Bank has become more active in the bond market, making purchases of government bonds to support the market for debt from the euro zone's periphery. But market watchers wonder whether the ECB can stem the tide if sentiment continues to sour.

Fiscally struggling EU countries keep trying to solve their budget woes. The Irish government recently doubled the amount of cuts it will make over the next four years to €15bn to bring down deficits. But economists worry that the austerity drive will deepen Ireland's recession.

Spain's statistics office added to the gloom last night by confirming that the Spanish economic recovery conked out in the third quarter. Gross domestic product came in flat from the previous quarter after only two periods of growth. Spain has slashed investment, cut public-sector wages and raised the rate of its value-added tax.

Renewed questions on whether ailing government treasuries can sustain rising borrowing costs have put into high relief the functionality of the EU's new bailout facility, which hasn't been tested and remains under review. The German and French governments, in particular, want to toughen rules to protect EU taxpayers from covering the cost of a sovereign default.

The change most dreaded by investors is Germany's push for a provision that defaulters must restructure their debt if they become shut out of credit markets. This would shift the losses from EU taxpayers to investors, but also could chill investor interest in riskier euro-zone government debt.

- Nathalie Boschat, Mark Brown and Clare Connaghan contributed to this article.