The euro should rally and peripheral bond yield spreads tighten as markets react with relief in coming days to Sunday's 110 billion euro bailout for Greece, but significant risks remain. While the rescue package should remove the threat of a Greek default and reduce the pressure that has sent borrowing costs for Greece and other highly indebted euro zone states soaring, uncertainty remains over German parliamentary approval and Greek implementation of the deal, analysts said. And initial market relief will not return prices to pre-crisis levels. “The market's nerves should be reduced but it's not the silver bullet,” said Peter Chatwell, rates strategist at Credit Agricole in London. Worries first over how Greece would pay its debts and later whether the crisis would spread to other euro zone countries have weighed on the euro and government bond yields for months. The single currency, down nearly 12 percent against the dollar this year, plumbed a one-year low last week before recovering on expectations the European Union and International Monetary Fund would soon announce a rescue for Greece. “The market will cautiously give a thumbs-up to this tomorrow but I'm not overly optimistic that the euro is going to recover fully from where it's come from,” said Kenneth Broux, markets economist at Lloyds TSB in London. London markets are closed on Monday for a holiday although others in Europe will be open, but the London closure will sharply restrict volumes. The euro stood at about $1.3342 in late New York trading on Friday and Audrey Childe-Freeman, currency strategist at Brown Brothers Harriman in London, said it could rally back towards $1.35. “I don't think the upside is very dramatic from here,” she said, adding the euro had held up quite well in the crisis. European finance ministers triggered the rescue package on Sunday after Greece committed itself to years of austerity. German Chancellor Angela Merkel, facing a tough regional election, vowed to fight for parliamentary approval of the package by Friday. However, Broux said that if Merkel were to do badly in the election in the state of North Rhine-Westphalia, market anxiety could return. As fears of a possible Greek default grew in recent days, Greek borrowing costs surged, with the 10-year bond yield topping 10 percent in thin trade last week after debt downgrades for Greece and Spain. The premium investors demand to hold Greek bonds over German benchmark Bunds, seen as the euro zone's' safest sovereign debt, hit a series of records, topping 1,000 basis points on Wednesday. The spread snapped back sharply on Friday in anticipation of a deal. Chatwell said that while yields spreads over Germany would come in somewhat, Greek yields would remain at elevated levels. Any sign the Greek government was not implementing the austerity measures to which it had agreed could see pressure return to markets, he said. Michael Cheah, senior portfolio manager at SunAmerica Asset Management, said the euro could fall as markets took the view the deal only fixed a short-term liquidity problem. “The signing governments will have serious domestic problems because you will see taxes go up and a decline in government spending,” he said. Shares seen up European shares, particularly banks, have also suffered. “Probably shares will go up, mainly banks, the Bund will go down and the spreads of peripheral countries will also go down,” said Christian Jimenez, fund manager and president of Diamant Bleu Gestion in Paris. “But the movement may not be so strong because of the uncertainties that remain,” he added. Although Greece has been the markets' main target, bond yields have also risen in Portugal and, to a lesser extent, in Spain, which were seen as the next weakest links. Chatwell said the contagion risk should be reduced along with market volatility but this would throw the economic fundamentals of euro zone states into focus. Lena Komileva, head of G7 market economics at Tullett Prebon in London, said other countries had relied on debt-fuelled growth to finance unsustainable levels of public spending and needed to take similar corrective action to Greece. “It is too early to say that the sovereign crisis is over,” she said.
