Europe gets a breather before bank stress tests

The markets have given Europe some respite in its struggle against debt but the EU faces a moment of truth this week with tests that will show whether banks can survive a new economic cataclysm.

European Union governments hope the results of "stress tests" on the banking industry, which will be released on Friday, will reassure investors worried about the banks' exposure to the continent's sovereign debt crisis.

"It is clear to my mind that the stress test exercise is of paramount importance to restore confidence in the European economy," European Economic Affairs Commissioner Olli Rehn said this week.

The markets have turned their attention to the health of banks after an explosion of public deficits and debts in the 16-nation eurozone weakened the single currency.

The debt drama forced European governments to bail out Greece and set up a 750-billion-euro ($950-billion) safety net with the IMF for other countries to tap into if they get in trouble.

But Greece, Spain and Portugal have successfully raised money in the bond market in recent days after being battered for months by soaring interest rates demanded by investors concerned by their shaky public finances.

"Everything indicates that the situation is normalising," Klaus Regling, head of the European Financial Stability Facility, which oversees the eurozone rescue fund, told French business daily Les Echos.

Spain passed a new test on on Thursday when it borrowed three billion euros through a 15-year bond issue which garnered strong demand.

Portugal had raised 1.68 billion euros a day earlier despite a new downgrade of its debt by the Moody's international credit rating agency.

Greece, the epicentre of the debt storm, raised more than 1.6 billion euros on Tuesday in its first operation since a last-minute, 110-billion-euro bailout from the EU and IMF saved it from default just two months ago.

"What some people considered was not possible is possible," Luxembourg's central bank governor Yves Mersch, a top member of the European Central Bank, told The Wall Street Journal.

But the eurozone is not out of the woods yet.

Greece, Spain and Portugal still have to pay high premiums to borrow money, a sign that investors still see risks involved in lending money to them. The rates demanded for Greek and Spanish bonds were slightly higher than in April.

The big test comes on Friday, when the results of stress tests on 91 banks accounting for 65 per cent of the European banking system are released, and the markets will pay particular attention to the health of Spanish institutions.

Markets want full disclosure of the results, but European finance ministers vowed this week that the test would be transparent as they refuted concerns that the tests would be crafted in a way to ensure positive results.

"Not just in credit markets but in wider markets too the key focus for the week ahead will be the stress tests," said an analysis by Dutch bank and insurance group ING.

"The greatest fear is that the test shows too little diversification between the good, the bad and the ugly and is seen by the market as being too optimistic," it said.

Economists warn that the results could reveal that some banks exposed to bad debt need injections of fresh capital.

Banks in Spain could need a total capital injection of 50 billion euros ($63 billion), analysts at Royal Bank of Scotland estimated.

The eurozone's economic prospects have also become a concern after governments launched austerity programmes with deep spending cuts and tax hikes to slash their massive public deficits.

The single currency area posted growth of just 0.2 per cent in the first quarter and is expected to rise only slighty more in the second quarter before slowing down in the second half of the year, according to German, French and Italian forecasts.

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