Korean shelling, European debt strains rattle markets

LONDON: Gunfire between the two Koreas raised alarm on global markets already focused on Tuesday on widening debt strains and pressure for new direction in the eurozone three weeks before an EU summit.

Shelling between North and South Korea, and the Irish-eurozone debt crisis, pushed up the dollar up, the euro down, and stocks slid with European banks shares falling sharply.

In late London trading the euro dived to 1.3370 dollars, near a two-month low. That compared with 1.3622 late in New York on Monday.

The dollar lost ground to the yen, trading at 82.83 against 83.29 on Monday evening.

"Geopolitics have thrown the market for a loop this morning, courtesy of a provocative action by North Korea," said Patrick O'Hare of Briefing.com.

In addition the positive effect has worn off from the weekend announcement that Ireland would seek an EU-IMF bailout estimated to be worth up to 90 billion euros (120 billion dollars).

Instead market focus shifted to the details of the package and how Europe plans to deal in the long term with eurozone members who land in trouble.

With a European Union summit set for December 16, Germany warned that with the rescue for Ireland, "it's our common currency that's at stake".

Analysts spoke openly of threats to survival of the eurozone, and a need for quick signals about how the European Union intends to reform it and under which rules.

At Rabobank in London, senior currency strategist Jane Foley told AFP that from an economic viewpoint the single currency was always "flawed" but had been carried by high political will.

The Stability pact intended to enforce budget discipline with fines "has severe failings, no one was ever fined."

She said that "the next few months will be critical" and that "fiscal discipline must be restored" in which case the conditions would become "conducive to a stronger euro."

Analysts said that the details of which mechanisms would be used to rescue Ireland would be crucial to market understanding of underlying pressures at work.

They would send important signals about sensitivities over drawing on a 440-billion-euro (590-billion-dollar) rescue fund called ESFS, set up during the Greek rescue.

German Finance Minister Wolfgang Schaeuble warned Tuesday that its "our common currency that's at stake" over the Ireland rescue.

His comments came against a background of virulent German press comment demanding German-style discipline for the eurozone and the day after Deputy Foreign Minister Werner Hoyer, commenting on the rescue for Ireland, said: "It is even more important that we start on a permanent (rescue) mechanism in Europe during the European summit in December."

The head of the European Central Bank, Jean-Claude Trichet, has called for a "quantum leap" in the bloc's economic governance, saying on Monday that 2011 would be a decisive year.

Analysts say that debt tensions in the eurozone rose sharply in the last three weeks largely because of uncertainty about what will happen when temporary rescue mechanisms end. They say clarification is needed about pressure launched by Germany for bond holders to be forced to bear part of the costs of bailouts in future.

In the end the Europe Union will need to confront again how monetary union will work, either with tough and enforced budget rules as desired by Germany or moving towards a transfer union where help from rich countries to poor is institutionalised.

Market comment focused again on the possibility that Portugal and Spain might also have to ask for help, a possibility rejected by the two countries but signalled in tensions on their debt markets.

The interest rate which Spain has to pay to borrow short-term money nearly doubled on Tuesday.

The difference, or spread, between the rate that Spain must pay to attract funds for 10 years, and the rate paid by Germany which represents the benchmark rate in the eurozone, also rose on Tuesday to a new historic high or 2.361 percentage points.

It is now at a wider level than at the peak of the Greek debt crisis.

The yield on Portuguese 10-year bonds rose to 6.732 percent from 6.523 percent the previous day, while the yield on Irish bonds climbed to 8.235 percent from 7.869 percent.

At Capital Economics, senior European economist Jennifer McKeown said that "the small risk" that Spain might need help "is perhaps the most serious threat to the eurozone's future."

She estimated that a rescue for Spain might soak up 420 billion euros. "Europe might be unable to stretch this far," she said. Although the risk of a Spanish bailout was "fairly low", she said that "the cost would be devastatingly high."

This threat was therefore "closely linked to the risk of some form of eurozone break-up," she commented.

Another Capital Economics analyst Jonathan Loynes said they had made the "bold judgement" that the chances of "some form of change to the eurozone over the next five years have risen above 50 percent" and that this possibility would have big effects on financial markets for "coming months and years."

European stock exchanges tumbled as such concerns mounted, with banking shares particularly hard hit.

The London FTSE 100 index dropped 1.75 percent to close at 5,581.28 points, while in Paris the CAC 40 fell percent 2.47 percent to 3,724.42 and in Frankfurt the DAX shed 1.72 percent to finish at 6,822.05 points.

Elsewhere there were falls of 3.05 percent in Madrid, 2.07 percent in Milan, 2.22 percent in Amsterdam and 2.13 percent on the Swiss Market Index.

On Wall Street equities were also hit by the incident in the Koreas and European debt concerns, with the blue-chip Dow Jones Industrial Average was down 1.56 percent at mid-day at 11,004.66 while the tech heavy Nasdaq had lost 1.75 percent to reach 2,487.66.