Ireland's central bank governor conceded on Wednesday that a huge bank-recapitalization program had failed to reassure investors, as borrowing costs mounted along with concerns its new fiscal plan would not avert a bailout.
Ireland's fragile government is battling to prove it does not need a Greek-style rescue to help it reduce the worst budget deficit in Europe, with markets worried it will struggle to pass the first of four austerity budgets next month.
The European Union's top monetary official said Ireland had not requested any financial aid, but the premium investors demand to hold 10-year Irish bonds rather than German benchmarks has widened at the same breakneck speed as Greece's spread did shortly before it sought its bailout in May.
Finance minister Brian Lenihan said late on Tuesday he believed action the government was taking would ensure it could repay its debts, and Central Bank Governor Patrick Honohan said the austerity measures would be unlikely to change even if external help was sought.
"My take would be the sort of policy package the IMF would want to see Ireland doing is very much the sort of policy package that the government is putting together on the fiscal side," Honohan told a conference on Wednesday.
The governor was replying to a question but said nothing about whether he thought Ireland would need outside help.
The 10-year Irish/German government bond yield spread rose by around 70 basis points to a record high of 645, breaching the 600 mark for the first time.
"So far, not least because of the rest of the fiscal burden remaining such a challenging problem, investors are not yet fully convinced (about the bank action)," Honohan said.
Ireland shocked investors in September when it said the final bill for purging its banks of years of reckless lending could top 50 billion euros, feeding skepticism about the country's ability to get its fiscal house in order.
Markets have since turned their attention to Lenihan's planned 15 billion euro ($20.6 billion), four-year fiscal adjustment and whether the government's slim parliamentary majority will last long enough to pass 6 billion worth of spending cuts and tax hikes next month.
Many now think only a general election that would give the opposition a workable majority will calm jitters.
However, given that it is costing Ireland 7.76 percent to borrow over as little as two years , analysts believe the country might still opt for a European Union bailout, which would cost around 5 percent but come with tough conditions.
One said the government would try to put off such a call as long as possible since it is fully funded to mid-2011.
"It's difficult to say in terms of a timeline as the government is going to do everything they can not to take it," Brian Devine, chief economist at NCB Stockbrokers said. "In terms of how likely, I think it's pretty likely at this stage."
Even if Ireland receives an international bailout, bond investors fear they could eventually be forced to pay part of the cost of cleaning up its debt.
The European Union is considering proposals to create a permanent mechanism to handle economic risks in the zone, and some members, including Germany, are pressing for this mechanism to contain a procedure for the orderly restructuring of countries' sovereign debt.
Honohan said Germany's proposals had helped destabilize markets and needed more articulation.
LCH.Clearnet, which clears Irish government bonds on behalf of its investment bank clients, said before market open on Tuesday that it would increase the margin required to trade Irish sovereign debt by 15 percent as of Thursday.
The European Commission approved the extension of Ireland's guarantee of bank liabilities until June 30 next year, and Honohan said the dependency on government and ECB support might be extended for another couple of quarters.
The guarantee means that the fortunes of the country and the banks are tied. Higher sovereign yields translate into higher funding costs for the banks, which in turn lead to higher borrowing costs for consumers and lower economic activity.
Honohan said the central bank would take a closer look at banks' residential mortgage books, stoking fears that Ireland may yet have to do more to bolster its discredited lenders, left deeply in debt when property and construction markets imploded.
A slump in commercial property prices brought the banks to the brink of collapse last year and residential mortgages are seen as the next big threat. Irish house prices have fallen 36 percent from their peak at the end of 2006.
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