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Why Europe's debt crisis is still spreading

European credibility seems to be the issue. Investors are increasingly edgy over whether EU policymakers can agree on how to ease the debt crisis.

By Correspondent / August 4, 2011

President of the European Central Bank Jean-Claude Trichet listens to a journalist's question during a news conference after a council meeting in Frankfurt, central Germany, Thursday, Aug. 4. The European Central Bank decided to keep the main interest rate unchanged at 1.5 percent.

Mario Vedder/dapd/AP

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Madrid

Europe’s economy remained in critical, but stable condition Thursday, as risks mounted of a double-dip recession in big economies like Italy and Spain that could compound woes elsewhere, including the United States.

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Markets grew ever more skeptical that European policymakers will be able to agree on measures to stem the crisis in time, as investors lose faith in the region’s convoluted decision-making process.

Indeed, crisis talks are ongoing. Political and financial leaders are even delaying their sacred August vacations. And the European Union’s executive head, EU Commission President José Manuel Durao Barroso, released a letter Thursday addressed to country leaders illustrating just how desperate times are.

“Developments in the sovereign bond markets of Italy, Spain, and other euro area member states are a cause of deep concern. Though these developments are clearly unwarranted, they reflect a growing skepticism about the systemic capacity of the euro area to respond to the evolving crisis,” Mr. Barroso wrote. “Whatever the factors behind the lack of success, it is clear that we are no longer managing a crisis just in the euro-area periphery.”

The European Central Bank (ECB) decided today to leave interest rates unchanged at 1.5 percent and offered cheap credit to eurozone private banks to increase liquidity. Both moves were expected and simply acknowledge that the economy of the 17-member eurozone is grinding to a halt and that inflationary pressure is secondary to growth issues.

That mirrors Swiss and Turkish decisions to cut rates this week, and the Bank of Japan’s new stimulus measures. The Bank of England also left rates unchanged.

Market jitters

But markets were more interested to hear whether the ECB would buy sovereign debt of peripheral economies – especially of Italy and Spain – to ease pressure on the cost of borrowing, at least until EU leaders and parliaments translate words into action by doubling the effecting contingency bailout fund to 500 billion euros ($711 billion).

And they were disappointed. The ECB hinted that it would resume bond buying, but it left the market guessing whether that would include Italian or Spanish debt. Initially falling, interest rates increased Thursday across the board, in the Italian and Spanish case to nearly 6 percent. European institutions once again disappointed the markets.

Both countries, considered “too big to fail,” are paying close to 4 percentage points more than Germany. It’s a huge difference that – if sustained over a long period of time – could derail the countries’ return to growth. That in turn could trigger a broader eurozone recession that would ripple out to the US, Asia, and elsewhere.

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