London: European shares fell sharply on Monday morning after draft budget figures showed Greece would miss its deficit targets this year and next, which might result in it seeking more bailout funds from international lenders.
However, other euro zone governments, faced with domestic opposition, may be unwilling to step in and fill the gap, raising the prospect Greek bondholders, mainly financial institutions, would need to take a bigger haircut than that previously agreed.
Should Greece fail to get additional financing from international lenders or if the private sector failed to agree to a bigger haircut, or writedown, on its debt, it might be forced to default.
Banks , down 3.4%, underperformed the pan-European FTSEurofirst 300 index . The banking sector has fallen a third in value this year.
Highlighting the problem for financial institutions, Belgian and French finance ministers were due to meet on Monday to discuss ways to shore up the balance sheet of financial services group Dexia , whose shares lost 8.1%.
Among other top losers in the banking sector were Commerzbank and Societe Generale , down 5.7 and 6.7% respectively.
The FTSEurofirst 300 index of top European shares was down 2% at 904.98 points by 0840 GMT, after losing nearly 17% in July-September, its biggest quarterly loss since late 2008.
“The fact that they are at least acknowledging the size of the problem as such, that they need such a large package, is a positive sign. Ultimately, Greece would need to see its debt written down by more and with that you need probably some kind of shoring up of the banking sector,” said Alec Letchfield, chief investment officer at HSBC Asset Management.
“But the problem you would then have is to get the 17 (euro zone) governments together to agree on something. It is very difficult to do that ... Until we get a bigger and better package coming through trading will remain volatile and often capped.”
Letchfield said some defensive shares were getting expensive. The MSCI healthcare sector, for instance, was more expensive than the MSCI Europe index . According to Thomson Reuters Datastream, the healthcare sector carried a one-year forward price-to-earnings (P/E) ratio of 10.2 versus the MSCI Europe’s 8.8.
Within the healthcare sector, Essilor International , Synthes , Straumann and Sonova had 12-month forward P/E ratios above 18, while AstraZeneca was the cheapest with a forward P/E of 7, followed by Celesio at 7.2.
Automakers , among the cyclical sectors whose performance is highly correlated with economic growth, fell 3.8% on Monday, with BMW down 5.7%.
UBS economist Larry Hatheway did not expect much relief from uncertainties in the euro zone in the coming months.
“Policy responses will remain mostly monetary, in the form of rate cuts and a further easing of liquidity conditions for banks,” he said in a note, adding the European Central Bank was likely to cut interest rates by 0.5%age point on Thursday.
“After national parliaments complete ratification of the expanded EFSF (bailout fund) mandated by mid-October, (we) expect more wrangling and uncertainty about how to bolster Europe’s financial sector.”
The Euro STOXX 50 volatility index , the euro zone’s fear gauge, rose 5.6% to hit a one-week high, indicating investor wariness of the situation.