European sharemarkets again staged a euphoric rally overnight, on hopes that European politicians will soon unveil dramatic plans for dealing with the region’s raging debt crisis, and that the European Central Bank will cut interest rates.

European bourses were the biggest winners, with Paris climbing 5.7%, Frankfurt 5.3% and Milan 4.9%, while London finished 4% higher. European banks, which have seen their share prices plunge in recent months because of worries over their large exposures to the eurozone’s debt-laden countries, were the strongest performers.

But Wall Street’s rally sputtered as traders ran into a grim reality check following a Financial Times report that eurozone countries are split over the terms of Greece’s second €160 billion ($US217 billion) bailout, with some pressing for banks and pension funds to take a larger write-down on their holdings of Greek bonds.

Markets have rallied strongly since the weekend, swept along by a frenzy of speculation that European politicians are about to boost the firepower of the eurozone’s €440 billion bailout fund.

However, Germany, which is the biggest contributor to the bailout fund, has been at pains to douse these rumours. A spokesman for German Chancellor Angela Merkel said the German government did not approve of further changes to the bailout fund beyond those agreed by eurozone leaders at their July meeting. At that meeting it was decided that the bailout fund’s powers should be extended so that it could buy the bonds of debt-strapped eurozone countries and inject capital into eurozone banks. “The maximum size remains €440 billion,” she said.

These changes to the bailout fund are expected to be ratified by the German Parliament at a crucial parliamentary vote on Thursday. But Merkel faces a revolt within her centre-right coalition, with several deputies threatening that they’ll vote against the new measures. And their dissatisfaction has been increased by the latest rumours about leveraging the bailout fund, which they worry will expose German taxpayers to even greater losses.

In order to reassure the dissidents, German Finance Minister Wolfgang Schäuble, who had previously seemed prepared to look at the possibility of leveraging the bailout fund, backed away from the approach. Speaking in Berlin this week, Schäuble ruled out boosting the size of the fund and overnight he went further, calling it a “stupid idea”.

But it is unclear whether Merkel has done enough to reassure the rebels in her coalition ranks. As a result, Merkel may have to rely on support from opposition parties to get the measures passed, which will seriously weaken her political authority and hamper her ability to respond to the worsening eurozone crisis.

Meanwhile, France is watching the upcoming German vote with extreme interest. French Prime Minister François Fillon said that as soon as the vote was over, France would outline some proposals to step up the battle on “speculative attacks” on the eurozone. French newspaper Le Mondequoted a French government source as saying that it would be possible to take some “tough decisions” on Greece and the banks once the German Parliament had voted.

At the same time, officials from the “troika” (the European Union, the European Central Bank and the IMF) are heading back to Athens this week. Markets interpreted the troika’s return as a positive sign because it signals that Greece, which runs out of money in mid-October, has taken sufficient steps to receive the next €8 billion payment from its bailout package.

*This article first appeared on Business Spectator

Peter Fray

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