Europe’s crisis hits new pitch on ‘deep depression’ warning

PARIS—Europe reeled on Monday from warnings it faces “deep depression” if the eurozone collapses and that every EU nation’s credit rating could be hit without firm action to stop the debt crisis.

An updated growth report from the OECD said the eurozone debt crisis was now just one step away from plunging advanced economies into an abyss of recession and could trigger waves of bankruptcies and wealth destruction.

And one of the world’s three main ratings agencies, Moody’s, warned even countries such as Germany may have to have their credit status revised – a move that would force them to pay higher borrowing costs.

Italy, the focus of warnings from Germany and France that if it cannot dominate its debt problem it will wreck the eurozone, struggled to raise funds on the bond market

Despite the glut of bad news, stocks rose after reports that the International Monetary Fund was readying a bailout for Italy. The markets in Milan, Frankfurt and Paris all registered upswings of more than three percent.

The IMF denied that talks on any such deal were taking place.

The report by the Organization for Economic Cooperation and Development made grim reading as it forecast the United States faced a period of slow growth, Japan’s economy would shrink 0.3 percent this year and developing nations would also see a slowdown.

But its starkest warning was reserved for the 17-nation Eurozone, which it said was set for growth of 1.6 percent and next year just 0.2 percent.

The OECD said there was still time for decisive action by policymakers to shore up stricken credibility and avert a far worse outlook, urging the European Central Bank to buy up devalued government debt bonds in huge quantities.

That advice flies in the face of an insistence by Germany, which has so far rejected extra bond purchases, arguing that the priority is for countries in trouble to reform their economies.

It spoke openly about the possibility of a eurozone break-up, saying an exit by one or more countries “would most likely result in a deep depression in both the exiting and remaining euro area countries as well as in the world economy.”

“The euro area crisis represents the key risk to the world economy at present,” the OECD said. “A large negative event would… most likely send the OECD area as a whole into recession.”

Moody’s also evoked the prospect of the eurozone fragmenting, saying “the probability of multiple defaults … is no longer negligible” and that would “significantly increase” the likelihood of one or more members dumping the currency.

“Moody’s believes that any multiple-exit scenario – in other words, a fragmentation of the euro – would have negative repercussions for the credit standing of all euro area and EU sovereigns,” the agency added.

“The continued rapid escalation of the euro area sovereign and banking credit crisis is threatening the credit standing of all European sovereigns.”

The European Union’s three biggest economies, — Germany, France and Britain – have so far maintained their triple A credit rating

But countries such as Italy, Spain, Greece, Ireland and Portugal have all suffered rating downgrades that accelerated unsustainable rises in their borrowing costs over the past two years.

A weekend report in Italy’s La Stampa newspaper had said the IMF was readying a bail-out package worth up to 600 billion euros ($800 billion), giving new Prime Minister Mario Monti a window of 12 to 18 months to implement urgent budget cuts and growth-boosting reforms.

Greece, Portugal and Ireland have all received bailouts in the last 12 months but a bailout of Italy, the eurozone’s third-biggest economy, would be on a totally different scale.

Italy’s 1.9-trillion euro ($2.5-trillion) public debt and low growth rate have spooked the markets in recent weeks.

La Stampa said the IMF would guarantee rates of 4.0 percent or 5.0 percent on the loan – far better than the borrowing costs on commercial markets, where the rate on two-year and five-year government bonds has gone above 7.0 percent.

Italy needs to refinance about 400 billion euros in debt next year.

The size of the loan would make it difficult for the IMF to use its current resources so different options are being explored, including possible joint action with the European Central Bank in which the IMF would be guarantor.

La Stampa‘s report led to an upturn on the European markets and shares were also up in Asia’s main markets, with Tokyo rising 1.56 percent while Seoul closed 2.19 percent higher.

In a one-sentence statement, the IMF denied it was holding talks.

“There are no discussions with the Italian authorities on a program for IMF financing,” said the Washington-based organization.

But analysts said the markets were unconvinced by the IMF denial and that sentiment was also given a lift by a separate report that German Chancellor Angela Merkel and French President Nicolas Sarkozy are considering a new stability treaty that would be limited to only a few countries in the eurozone.

“The rally from a fundamental point of view is being assisted by rumors that the IMF is concocting some sort of elaborate bailout plan for Italy,” said Simon Denham, head of Capital Spreads trading group in London.