(Updates bonds, euro in seventh paragraph, adds Papandreou conference call in ninth.)
Sept. 13 (Bloomberg) -- German Chancellor Angela Merkel said Greece is taking the right steps to get its next bailout payment, warning against allowing a Greek default because of the risk of contagion for other euro-area countries.
Merkel, in a German radio interview broadcast today, said that an “uncontrolled insolvency” would further roil markets spooked by the prospect of a Greek default. The euro region currently has no system for “orderly” insolvency until the permanent rescue fund is established in 2013, she said.
“The top priority is to avoid an uncontrolled insolvency, because that wouldn’t just hit Greece and the danger that it hits everyone, or at least a number of other countries, is very big,” Merkel told Berlin-based broadcaster Inforadio. “I have made my position very clear: that everything must be done to keep the euro area together politically, because we would very quickly face a domino effect.”
Merkel’s comments are a rebuff to calls by members of her ruling coalition to consider allowing Greece’s insolvency and exit from the currency union as it struggles to satisfy the terms of its aid package. They also belie government plans to support German banks in the event that Greece goes into default.
The interview, posted on the website of the chancellor’s Christian Democratic Union party, is “typical Merkel,” Holger Schmieding, chief economist at Joh. Berenberg Gossler & Co., said by telephone from Hamburg.
“It does not completely rule out an orderly default, except that the entire tone of the interview very clearly suggests that her position is that she expects Greece to qualify for the next tranche,” he said. That she mentions the European Stability Mechanism allowing for orderly defaults from 2013 “suggests that she does not expect Greece to default now.”
Greece’s 10-year bond yield rose 109 basis points, or 1.09 percentage point, to 24.63 percent as of 5:08 p.m. in Berlin, after earlier climbing to a euro-era record of 25 percent.
The euro traded near its weakest level in a decade against the yen and fluctuated versus the dollar, declining less than 0.1 percent to $1.3676.
Greek Prime Minister George Papandreou will hold a conference call with Merkel and French President Nicolas Sarkozy tomorrow to discuss developments in Greece and the euro area, his office in Athens said.
Merkel, asked later at a press conference with Finnish Prime Minister Jyrki Katainen whether she saw Greece defaulting, called for the Greek government to be given time to reduce its debt and carry out the necessary economic reforms.
‘Yearning’ for Answers
“We all feel a yearning, that there might be one buzzword that solves the problem we have in the euro area, in other words the debt crisis, whether it’s euro bonds, insolvency or other words,” Merkel said. “That won’t happen. I’m deeply convinced of that. Rather, it will be a very long, step-by-step process.”
Philipp Roesler, the vice chancellor and economy minister who heads Merkel’s Free Democratic Party coalition partner, said in an op-ed published in Die Welt newspaper yesterday that there can be no “taboos” when considering action “to stabilize the euro in the short term,” including a Greek insolvency.
Germany’s best-selling Bild newspaper today cited his comments as a factor unsettling markets. Merkel slapped him down in her radio interview, saying that “everybody should weigh their words very carefully.”
“What we don’t need is unrest in the financial markets,” she said. “The uncertainties are big enough as it is.”
Finance Minister Wolfgang Schaeuble, a CDU member like Merkel, denied that Roesler was calling for Greece to be allowed to go into default.
“He didn’t put the plan on the table, he said you can’t rule anything out,” Schaeuble said in an interview with ZDF television late yesterday. “A government has to consider what should happen in case of a catastrophe.”
German coalition officials stepped up their criticism of Greece last week after a delegation from the European Commission, European Central Bank and International Monetary Fund suspended a report on progress made in Athens in meeting the terms of its rescue program. The delay threatened to derail the next payment to Greece due next month.
Merkel offered her backing for Papandreou’s government, saying that a team of officials from the three institutions is returning to Athens this week, which “suggests that Greece has taken care of a few things” to meet the bailout conditions.
“Everything I hear out of Greece is that the Greek government has hopefully seen the writing on the wall and is now doing the things that are on the agenda,” she told Inforadio.
Merkel’s “entire tone is that she is encouraging Greece to do what it takes and if Greece does what it takes, the next tranche will be paid,” said Schmieding.
While she leaves open a back door to possible Greek insolvency, “the escape clause is not the message,” he said. “The message is she will not expect an escape clause to be used.”
--With assistance from Patrick Donahue in Berlin Editors: Alan Crawford, Simone Meier
To contact the reporters on this story: Tony Czuczka in Berlin at email@example.com; Mariajose Vera at firstname.lastname@example.org
To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.