Markets nervous over EU debt contagion

The fear of European debt contagion is spreading through financial markets, says Chris Towner, director of advisory services at HiFX.

While Towner says that the problems in Greece have been severe, he believes that they would look comparatively mild if the debt crisis spread to other, larger economies.

"The sovereign debt crisis in the EU is spreading as the financial markets stand on the threshold between heightened nervousness and panic," said Towner.

"The reason for this nervousness is that the crisis is now spreading into countries that are too big to save."

"Italy is not just the third-largest economy in the EU but, more pertinently, it has the largest bond market and the fear is rising that the Italians may in the future start to struggle with their enormous debt levels, which are approximately 100 per cent of their annual GDP."

The comments come following a warning from the International Monetary Fund (IMF) that Italy must move quickly and effectively to enforce spending cuts.

The IMF stated that the country may have been too optimistic with growth forecasts and is urging the government to implement austerity measures.

Towner says that, in the face of the threat of default in the peripheries, investors are fleeing to larger, core economies in search of safety.

"Money needs to flow somewhere and we have seen the smaller more stable economies such as Switzerland and New Zealand attract investors seeking some form of a safe haven," he explained.

Ratings agency Fitch issued a special report to announce that it believed the Italian government would meet its austerity targets.

"In the absence of negative shocks, adherence to the fiscal targets set out by the government would be consistent with stabilising Italy's sovereign credit profile and rating at 'AA-'," said the report. "The stable outlook on Italy's sovereign ratings is based on Fitch Ratings' expectation that the government is likely to succeed in reducing the budget deficit as planned."

There has been a sharp rise in the yields of government bonds in recent weeks, reflecting a crisis of confidence in markets.

However, a quarterly report on the euro area published today by the European Commission claims that Europe is on the road to recovery.

"Significant steps towards fiscal consolidation have already been taken, and also structural reforms are underway," said the report.

"The Irish programme is well on track, while the Portuguese programme is still in an early stage. The situation is more complex in Greece, where despite substantial progress, strengthening of the programme is needed. The euro area's recovery from the deep 2009 recession remains on track."

While the report is positive on recovery in the eurozone, it warns that external shocks could have a drastic effect on the economy.

"Risks surround this scenario, not least those related to unrest in the Middle East and North Africa and its negative impact on oil prices."