The euro zone crisis took a fresh turn for the worse yesterday after Moody's threatened to cut Germany's coveted top credit rating and as fears grew Spain might soon need a full-blown bailout.
The shock decision to slash the outlook of Germany, Europe's top economy and paymaster, from “stable” to “negative” came as auditors arrived in debt-wracked Greece and Spain's top finance official headed to Berlin for talks.
The news pushed Spain's borrowing costs above 7.5 percent — well above the seven-percent mark that forced others into bailouts — and sent both European stocks and the euro tumbling.
Also weighing on confidence was a report that Spain needed a partial bailout to meet its refinancing needs and an admission from Greek Prime Minister Antonis Samaras that Greece's recession might be much worse than first feared.
Moody's said its decision was based on “rising uncertainty regarding the outcome of the euro area debt crisis (and the) ... increased likelihood of Greece's exit from the euro area.”
Even if Greece manages to stay in the 17-member bloc, Moody's said there was “an increasing likelihood that greater collective support for other euro area sovereigns, most notably Spain and Italy, will be required.”
Germany's top rating could be cut, Moody's said, if Berlin needed to shore up its banks as a result of the crisis, if the bloc were to split or if Germany were to see its own borrowing costs — currently at record lows — rise.
Policymakers raced to dismiss the action.
The head of the Eurogroup of euro zone finance ministers, Jean-Claude Juncker, immediately stressed a “strong commitment” to the bloc's stability after the warning, which also hit the Netherlands and his native Luxembourg.
Moody's latest decision “confirms the very strong rating enjoyed by a number of euro area member states, as supported by the sound fundamentals which these (three) and other euro area countries continue to enjoy,” said Juncker.
Germany's Finance Ministry was even more dismissive, saying in a statement late Monday: “The euro zone risks that Moody's mentions are not new.”
Berlin would maintain its “safe haven status” and continue to act as a “stability anchor in the euro area,” the ministry vowed.
But in another sign that Germany's resistance to the euro zone turbulence was fading, a key business confidence index slipped to a three-year low, prompting analysts to warn that the German economy could deliver below-trend growth.
In Athens, auditors from the International Monetary Fund, European Central Bank and European Union were arriving to review Greek progress towards securing a further slice of bailout cash before the country goes bankrupt.
Officials in Germany have insisted they will wait for this report, due in early September, before casting judgement on Greece's ability to stay in the euro zone as voices calling for a “Grexit” grow louder in Berlin.
As the auditors began work, Samaras said the Greek recession this year could be much worse than expected, with the economy shrinking by “more than seven percent.”
European Commission President Jose Manuel Barroso announced a visit to Athens for talks with Samaras on Thursday, his first since June 2009.
Other political efforts to contain the crisis were set to intensify, with Spanish Economy Minister Luis de Guindos due in Berlin for talks with German Finance Minister Wolfgang Schaeuble.
Berlin has insisted it is a “regular meeting” but spokeswoman Marianne Kothe acknowledged on Monday: “They will of course discuss the current situation in Spain” amid speculation Madrid will soon be forced into a full-blown bailout.
The meeting takes place behind closed doors and no news conference was planned following the meeting.
De Guindos insisted Monday that there was no possibility of a sovereign bailout after Spain clinched a rescue package last week of up to 100 billion euros ($121 billion) for its stricken banks.
But Spain's troubles showed little sign of abating Tuesday as it paid higher rates to borrow for three and six months, although demand was stronger than at a previous such auction.
Moreover, after a report in the Economista daily that Madrid wanted a line of credit to cover 28 billion euros in debt maturing in October, the finance minister of the key region of Catalonia confirmed he was to ask the central government for help.
“A Spanish sovereign bail-out would leave little left in the pot to provide further assistance to Portugal and Ireland and, much more crucially, to deal with serious problems in Italy,” warned Jonathan Loynes, Chief European Economist at Capital Economics.