Inspectors have released a damning progress report amid darkening outlook for Spain. Larry Elliott, Jill Treanor and Giles Tremlett report.
Financial market fears about a possible Greek exit from the eurozone were fanned on Tuesday night by a gloomy assessment of the country's economic plight from international debt inspectors and evidence of a growing rift between Athens and Berlin.
Officials from the so-called troika – the International Monetary Fund, the European Union and the European Central Bank – warned that Greece had failed to keep to the deficit-reduction plan agreed earlier this year.
Arriving in Athens for talks with the coalition government, one official was quoted as saying: "Greece is hugely off track. The debt sustainability analysis will be pretty terrible."
Another official pointed out the latest growth estimates from Athens, which show the economy contracting by 7% this year rather than the 5% previously forecast, meaning the debt burden is only increasing in relation to gross domestic product.
"Nothing has been done in Greece for the past three or four months," said the official, referring to the delays caused by the two elections held since May. German politicians have been ratcheting up pressure on the new government of Antonis Samaras in recent days, stressing that Greece can expect its financial lifeline to be cut off unless it agrees to a fresh round of deeply unpopular austerity measures.
Return of the drachma
Samaras reacted angrily to suggestions from Germany that Greece is incapable of meeting its bailout pledges and should start planning for the return of the drachma, branding the comments irresponsible.
"I say it openly and publicly: they undermine our national effort," Samaras said in a speech to party members. "We do all we can to bring the country back on its feet and they do all they can so we can fail."
The deteriorating situation in Greece coincided with another turbulent day on Europe's financial markets. Spain witnessed the interest rate on its 10-year debt climb to a record post-peseta level of 7.65% and shares closed at their lowest level for almost a decade amid mounting speculation that the eurozone's fourth-biggest economy would require a bailout of at least €300-billion.
Concern that financial help for Spain would leave Europe with insufficient funds to support Italy meant the Rome stock market fell to levels not seen since the creation of monetary union. Shares in London and New York were under pressure.
Lord Adair Turner, the chairperson of the United Kingdom's Financial Services Authority, admitted that he was "very concerned" about the eurozone crisis, which has been escalating amid fears that Spain may need a bailout. Turner said the new banking bailout facility needed to be able to recapitalise banks directly and cut the "fatal" tie between sovereigns and banks. "The eurozone will not be a stable system without rapid progress towards a banking union," Turner said.
Deutsche Bank was forced to issue an unscheduled trading update before figures scheduled for next Tuesday, warning that profit was lower than forecast as a result of the crisis that was affecting its cost base, which is rising because it is largely denominated in dollars and sterling.
Trouble at Spain's 17 regional governments continued to snowball as eastern Catalonia admitted that it had few funding options left to it and might have to ask for bailout money from the central government.
Prime Minister Mariano Rajoy's government has now set up a liquidity fund, but has made it clear money will come with conditions.
"The budget conditions imply presenting an adjustment programme and, if payments are not met, intervention," said Budget Minister Cristobal Montoro, referring to direct government control over the region's finances. – © Guardian News & Media 2012
<strong>... While Germany heads towards recession</strong></h2>
Germany's private sector shrank for a third straight month in July - a second blow to Europe's largest economy after Moody's cut its credit rating to AAA with a negative outlook.
Economists say the German economy may head into recession later this year, because it is likely its gross domestic product (GDP) fell in the second quarter and Tuesday's data point to another decline in the third quarter.
The Markit purchasing managers' index (PMI) for Germany fell to 47.3 this month from 48.1 in June. Any number below 50 means the sector is shrinking rather than growing and a lower reading means the private sector is shrinking faster than before.
Chris Williamson at Markit said: "There's a pretty clear picture in Germany of conditions really deteriorating very markedly, especially in manufacturing, and that's a symptom of domestic and export demand continuing to falter."
He expected German GDP to fall by 0.1% in the second quarter and said businesses would become more cautious as the eurozone crisis got worse. "That's going to cause them to cut back on investment and hiring so, unless we see quite a significant turnaround in the broader political and economic environment, I can't see any way of turning around from a further contraction in the third quarter."
French PMI data suggested it too was moving into recession. The Markit PMI for France rose to 48 from 47.3 in June. Manufacturing activity fell to 43.6, way below analyst forecasts for a reading of 45.5 in June. Activity in the services sector, on the other hand, was at its highest since January, with a reading of 50.2.
Jack Kennedy, senior economist at Markit, said: "A resilient service sector performance compensated for a sharper fall in manufacturing output during July. However, conditions clearly remain fragile, with the rate of job-shedding accelerating to the sharpest for over two and a half years in July. Faced with a weak economic climate both domestically and abroad, combined with ongoing uncertainty over the future of the eurozone, businesses are finding little reason for optimism at present."
Markit said the data suggested that French GDP would contract by 0.4% in the third quarter, after an estimated 0.6% fall in the second quarter.
Overall, the eurozone's private sector shrank for the sixth straight month in July, suggesting the region will head back into recession, with the eurozone PMI reading at 46.4. - Josephine Moulds, Guardian News & Media 2012