- Associated Press - Monday, May 23, 2011

LONDON — Europe’s debt crisis returned to shake markets on Monday as fears over the solvency of Greece combined with concerns that Spain, or even Italy, may be dragged into the turmoil that has already seen three euro countries bailed out.

Stocks and the euro tanked on a toxic brew of credit-rating downgrades, a heavy electoral defeat for Spain’s governing party and disagreements among top European officials on how to deal with the crisis.

“It was a bad weekend for the eurozone and in particular for those politicians and financial authorities trying desperately to keep the euro project together,” said Jeremy Batstone-Carr, director of private client research at Charles Stanley.

Investors watched aghast last week as top policymakers clashed over how to deal with Greece’s mountain of debt.

While policymakers at the European Central Bank warned of the catastrophic effects of a Greek debt restructuring, officials in Brussels suggested a delay in bond repayments could help give Greece more time to regain market trust.

Amid the confusion, Fitch on Friday downgraded Greece further below junk status and on Monday cut Belgium’s outlook, while Standard & Poor’s lowered Italy’s rating outlook on the weekend. Tensions were further heightened on Sunday when Spain’s governing Socialists took a battering at regional polls as voters protested against austerity at a time when one in five people are looking for work.

The epicenter of the market tensions, however, was in Greece, analysts said.

After repeated warnings that Greece is behind schedule in its austerity reforms, some investors worry the country may not get its next bailout installment — which it needs to avoid default — from its partners in the eurozone and the International Monetary Fund.

European officials have warned Greece needs to find cross-party support for new reforms, including privatizations, but that political unity seems distant.

Though Greece managed to get a $154 billion financial lifeline just over a year ago, the consensus in the markets is that it will have to get a second bailout in the next few weeks if it’s not to avoid some sort of default of its debt.

Prime Minister George Papandreou conceded as much over the weekend when he said the country was unlikely to be able to tap bond market investors next year — last year’s three-year package of loans was predicated on it being able to do so.

The prevailing view in the markets is that Greece will get more aid, partly because not doing so may cause an even bigger crisis for the euro. Austrian National Bank governor Ewald Nowotny suggested in Vienna on Monday that the EU Commission and IMF could consider more financial support.

With uncertainty lingering over Greece’s economic future, investors ran for cover, selling off stocks around the world. Markets outside Greece were affected because many foreign banks would be hit by a default there.

Most of Europe’s stock markets ended over a percent lower on Monday, with Italy’s main exchange underperforming with a 3 percent decline. The euro was clearly in the firing line, dropping more than 2 cents at one stage to briefly fall below the $1.40 mark for the first time in two months. The currency was down 0.7 percent at $1.4032 by late afternoon.

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