Euro zone bond frenzy echoes past battles

Yet big institutional investors are holding off, partly due to market volatility, but also because they want to see the Socialist government implement tougher public spending cuts.

“Greece in the long term is probably a good play but we have to wait for the government to see more signs on the expenditure side,” said Jorgen Christian Hansen of Danish pension fund Unipension.

“The reason Greece is getting so much attention is that it is the first real test of the Euro-system in handling countries with excessive debt and too lax fiscal policies,” he said.

EU governments will try to ride out the crisis without having to bail out Greece, or Portugal or Spain, by pressuring those countries to make draconian fiscal adjustments while declaring political support for them.

A single comment from Germany's finance minister a year ago that the euro zone would have to help if a member got into a serious situation was enough to calm market fever over Ireland.

The question is whether the EU can enforce budget discipline rules on peripheral euro zone states which its core members mostly failed to respect over the last decade. Compounding the problem, those countries have lost economic competitiveness, and austerity will further slow their recovery from recession.

Euro zone countries cannot devalue their way out of trouble. The alternatives for Greece are to make painful and politically risky cuts in public spending, to seek a bail-out or to default.

Athens has to refinance 54 billion euros in public debt this year, 20 billion of it in the second quarter. It faces a crunch at the end of the year if Moody's joins two other credit ratings agencies in downgrading Greek debt below A grade.

Unless the ECB changes its mind, that would cut Greek banks off from central bank refinancing operations by disqualifying their government bonds as collateral. Analysts say that would trigger a chain reaction of bank defaults. Outgoing EU Monetary Affairs Commissioner Joaquin Almunia shrugged off such disaster scenarios in a Jan. 29 Reuters interview, underlining to the fickleness of financial markets.

“You know the markets,” he said. “On other occasions, they became nervous one day and receded a week afterwards. I'm sure they'll find something bigger to worry about soon.”

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