The game is up for Ireland

Ireland faces double dip, mulls restructuring of junior bank debt

By Ambrose Evans-Pritchard, the Guardian Newspaper
Published: 7:24PM BST 23 Sep 2010

Irish borrowing costs have surged to a post-EMU record after Ireland’s recovery buckled over the summer and Dublin said creditors of Anglo Irish Bank may be asked to “share” losses, a warning to bondholders that the dam may at last be breaking on debt restructuring in the eurozone.

…Julian Callow from Barclays Capital said Ireland needs negative interest rates of –9pc under the ‘Taylor Rule’ on output gaps, while Austria needs +2pc and Germany +1.3pc – a divergence that exposes the headache facing the ECB as it runs a one-size fits-all policy for states with disparate labour laws and housing markets. He said the gap between EMU states had grown wider over the past two years. The self-correcting mechanism is not functioning.

Mr Callow said Ireland’s nominal GDP has contracted by 18pc since the peak. This partly due to deflation, which has helped the country claw back competitiveness lost in the bubble. But deflation is double-edged. Debt contracts are fixed in nominal euros, so the country risks a classic debt-deflation trap as the real burden of interest payments keeps rising.

Mr Callow said Ireland has a “get out of jail free card” in the form of dynamic exports – pharma, IT and services – but needs a “much weaker euro” to play that card. The euro surge against the dollar and sterling could hardly have come at a worse time.

(link to full article)