Germans ease austerity pace for Spain, markets in turmoil

BERLIN/DUBLIN (Reuters) - EU paymaster Germany softened its drive for austerity across the euro zone on Friday, agreeing to allow Spain more time to cut its deficit while its battles a deepening bank crisis, capital flight and recession.

Irish voters backed a European budget discipline treaty by a 60-40 percent vote in a referendum, a widely expected result that removed one political risk for the troubled currency area but left several bigger ones.

Investors stampeded to safe-haven U.S. and German government bonds amid growing worries over Spain's parlous finances and debt-stricken Greece's uncertain future in the single currency area, compounded by weak U.S. jobs data.

Asked about a European Commission call to grant Spain more time to reduce its deficit, a German Finance Ministry spokesman said Berlin understood Madrid's difficulties in trying to cut its shortfall to 3 percent of gross domestic product in 2013.

"We support Spain in its efforts to implement the necessary measures. But we also recognize that because of negative economic developments it will be difficult for Spain to reach its goals," spokesman Johannes Blankenheim told a news briefing.

Asked if that meant Madrid should be given more time, he replied: "I think that's what I've been saying.

Until now, Germany has taken a hard line with states missing agreed deficit targets, worried that accepting failure would weaken the commitment to consolidate and hit market confidence.

But officials close to Chancellor Angela Merkel have told Reuters that some budget goals now look unrealistic and need adjusting to reflect unexpected economic weakness.

New French President Francois Hollande, Italian Prime Minister Mario Monti, U.S. and IMF officials have called for an easing of the austerity drive to refocus on getting the European economy moving.

In Dublin, ministers voiced "a sigh of relief rather than celebration" that Irish voters had approved the fiscal discipline compact in the only plebiscite on the treaty in the 17-nation euro area.

The pact is meant to enforce EU deficit cutting rules more strictly to prevent a repetition of the sovereign debt crisis, but critics argue it is too rigid and could deepen recession if applied literally.

Ireland has been held up by its European partners as the model student for austerity, implementing an 85-billion euro ($106 billion) EU/IMF bailout to the letter as others, notably Greece, remained the centre of euro zone debt concerns.

Financial markets are more worried about accelerating capital flight from Spain, which is resisting pressure to seek international assistance for its banks, and a repeat general election in Greece on June 17 that could lead to that country becoming the first to leave the euro area.

In another day of market turmoil, German bond yields fell to all-time lows, with investors effectively paying Berlin to park their money in its coffers at negative real interest rates, while the borrowing costs of Spain and Italy are again becoming prohibitive.

The risk premium investors demand to hold Spanish 10-year debt rather than German bonds rose on Friday to its highest since the launch of the euro at 546 basis points.

BALANCED BUDGETS

Spain revealed on Thursday that investors had moved a record net 66.4 billion euros ($82 billion) out of the country in March alone, before the sudden nationalization of ailing lender Bankia , its fourth-largest bank.

Spanish Treasury Minister Cristobal Montoro sought to sooth markets by reporting that the country's autonomous regions had balanced their budgets in the first three months and we're on track to meet their 2012 deficit target of 1.5 percent of GDP.

The cabinet delayed plans to adopt a new mechanism to ease their funding problems and boost their liquidity positions but Montoro said he hoped to present the measure next week.

Overspending by the regions has been a big factor in the country's fiscal problems, along with mountains of debt owed to savings banks after a property bubble burst.

The European Commission, the European Central Bank, the United States and International Monetary Fund have stepped up pressure on euro zone leaders to adopt bolder measures, such as a banking union and a joint deposit guarantee, to ensure the euro's survival.

But Germany, keen to limit liabilities to its own taxpayers, has so far resisted such moves. Greater flexibility on deficit reduction targets costs Berlin nothing.

CONTRADICTORY POLLS

Contradictory opinion polls ahead of the June 17 election in Greece, the euro zone's most heavily indebted state, pointed to a knife-edge race between supporters and opponents of the tough terms of Athens' EU/IMF bailout.

In a sign of the depth of Greece's problems, the country's power regulator told Reuters he had called an emergency meeting next week to avert a collapse of the electricity and natural gas system due to unpaid arrears owned by power producers.

A poll victory for the anti-austerity leftist SYRIZA party, which wants to tear up the bailout agreement, could lead to the country being forced out of the euro.

Most polls show the conservative pro-bailout New Democracy party narrowly ahead of SYRIZA, one day before a ban on their publication comes into force.

But one survey by the respected Public Issue agency gave the leftist group led by charismatic Alexis Tsipras a six-point lead, reflecting the angry and unpredictable mood of voters exasperated with austerity and soaring unemployment but still keen to stay in the euro area.

Greece's electoral system gives the winning party an extra 50 parliamentary seats, making it almost impossible for rivals to form a government without it.

In a throwback, former Italian Prime Minister Silvio Berlusconi, ousted last year after financial markets lost confidence in his reform-shy government, said Italy should leave the euro unless the ECB agreed to pump more cash into the economy and guarantee government debts.

"We have to go to Europe and say forcefully that the ECB should start printing money," Berlusconi said in an entry on his Facebook page.

(Additional reporting by Kirsten Donovan in London, Harry Papachristou and George Georgiopoulos in Athens, Terhi Kinnunen and Eero Vassinen in Helsinki, Conor Humphries and Stephen Mangan in Dublin, James Mackenzie in Rome; Writing by Paul Taylor, editing by Mike Peacock)

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