Analysis: Saving Italy key to euro zone 2012 funding plans

Wed Dec 7, 2011 4:13pm EST
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By Marius Zaharia and Kirsten Donovan

LONDON (Reuters) - Euro zone countries will find it increasingly difficult to finance themselves at affordable interest rates next year unless policymakers can reassure investors within two months that Italy will be able to repay its debt.

One by one, even the most creditworthy borrowers could be forced to resort to bonds carrying ever shorter maturities, raising their costs and increasing their vulnerability to uncertain market conditions.

The region's funding needs are estimated at more than 800 billion euros next year -- a slightly lower total than in 2011, but one that could be much harder to reach. Each country's financing strategy depends almost entirely on the fate of Italy, which implicitly carries with it the fate of the currency union.

Financial systems in the euro zone are tightly interconnected and any shock in Italy would be immediately felt across the region, even in healthier economies such as France or Germany. French banks have $400 billion exposure to Italy, German banks have $200 billion of exposure to France, according to BIS data.

Investors are impatient and time is running out as Italy, whose bond yields soared close to an unsustainable 8 percent last month, has to repay more than 90 billion euros of bonds between February and April.

"At least in the first half of the year we should see pressure on all countries, especially Italy and France," Lloyds Bank rate strategist Achilleas Georgolopoulos said.

He said this could see more countries seeking to issue short-term debt as borrowing over 10 years or more became prohibitively expensive.

"The key signal that everything is going wrong will be a failed French auction. People will start to worry seriously about the euro," Georgolopoulos said.   Continued...