Euro plunges on fears of banking crisis

The Euro has plunged to a 16-month low and the Italian Bank UniCredit is warning investors of the potential risk of a euro-zone collapse. The drop in the euro comes from concern over the health of Europe's governments and their banks.

Jill Treanor and Nils Pratley
Thursday 5 January 2012 15.48 EST
The Guardian

The Italian bank UniCredit warned its investors of the potential risk of a break-up of the single currency as the euro was battered to a 16-month low against the pound on anxiety about the health of eurozone governments and their banks.

Trading in the bank's shares was halted five times on Thursday because of huge falls as shareholders digested the terms on which it was trying to raise €7.5bn (£6.2bn) to plug a hole in its regulatory capital.

Italy's market regulator, Consob, said it was looking at whether short-selling rules had been broken because of the 30% fall in the shares in the 48 hours since the terms of the rights issue were announced. Short selling allows punters to make profits on falling share prices and has been prohibited in parts of Europe.

The anxiety about the banking sector and fears about the ability of eurozone governments to repay their debts drove the euro to its lowest level against the dollar since September 2010, an 11-year low versus the yen and a near 16-month low against sterling.

The prospectus issued by Unicredit – whose shares are at their lowest since its creation in 1998 – to entice its investors to support the €7.5bn cash call spelt out the possibility of a collapse of the eurozone. In a series of risk warnings that always accompany such share offerings, the bank said "concerns that the eurozone sovereign debt crisis could worsen may lead to the reintroduction of national currencies in one or more eurozone countries or, in particularly dire circumstances, the abandonment of the euro".

City sources believed this was the first time the warning – inserted by the army of lawyers working for the 27 banks underwriting the cash call – had been carried in such a document but would not be the last. However, the bank insisted that it was not predicting a collapse of the eurozone. The warning went on to say that "any deterioration of the political and socioeconomic situation in Greece, as well as a decision by the group to participate in restructuring plans for Greek debt could result in even bigger losses for the Group than those recorded on 30 September 2011".

The bank reported a €10.6bn loss for the third quarter as a result of writedowns on its holdings of sovereign debt. Its cash call – while expected – has knocked sentiment in the wider European banking sector. Germany's Deutsche Bank was caught up in the rout, falling 6%. Spain's banks were also unsettled by a Financial Times report saying its banks would need to make €50bn of provisions to cover further losses.

Federico Ghizzoni, the boss of UniCredit, insisted to Il Sole 24 Ore newspaper he was "optimistic" that the capital increase would be successful.

Even so, the plight of the banks put pressure on the euro, which was also affected by attempts by eurozone governments to issue new bonds. The euro fell to 82.50p, its lowest since mid-September 2010, and touched $1.2776.

While France raised €8bn smoothly on the markets, there was lingering anxiety about the strength of demand for the bonds. The 10-year borrowing costs for €4bn of bonds rose only slightly to 3.29% from 3.18%. Analysts at Capital Economics said: "The immediate focus is on concerns about the potential loss of France's AAA credit rating, which was reflected in another lacklustre bond auction."

Italy's borrowing costs were driven above the troublesome 7% level, while Hungary, where investors are alarmed by the risk of a debt default, was plunged into deeper financial crisis as its government was obliged to pay 9.96% for short-term debt and failed to raise the full amount it was seeking.

The currency, the forint, plunged to a fresh low against the euro, a damaging blow for many Hungarian mortgage borrowers who took on loans denominated in euros and Swiss francs. Analysts expect the country's central bank to raise interest rates for a third time in quick succession to 7.5% to try to defend the value of the forint.

Investors have been further concerned by the nationalist government's deteriorating relations with the European Union and the International Monetary Fund, both of which are concerned by a new law that appears to restrict the independence of the Hungarian central bank. Street protesters have also denounced the country's new constitution as undemocratic.

Hungary needs to raise about $16bn (£10bn) in the market this year to fund its deficit and meet its debt repayment schedule. Without access to financial markets at rates far lower than 10%, the need for outside support could become urgent. Tamás Fellegi, the Hungarian finance minister pledged to be constructive in talks with the IMF. "We are ready to negotiate without preconditions and we are ready to discuss everything at the negotiating table," he said.

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