Debt mountain looms but euro zone can climb it

By Brian Love, European Economics Correspondent

PARIS (Reuters) - Europe faces a massive bill as grapples with the aftermath of recession and the cost of economic stimulus steps, but the surge in government debt looks manageable for the 16 countries that enjoy the protection of euro zone membership.

Europe's monetary union has survived the toughest test since it was launched in 1999, and continues to shelter even its most fragile and indebted economies from fears of default.

When Moody's announced on Thursday that it might downgrade Greece, the most indebted euro zone country after Italy, the spread of 10-year Greek government bond yields above German debt rose to around 144 basis points from 136 bps a day earlier.

But the spread remained well below the past decade's peak of 299 bps, hit at the height of the economic crisis in February, and far below the spread for the most heavily indebted European countries outside the euro zone. The spread for Poland is now around 290 bps.

Much of the markets' calm over soaring debt in euro zone members is due directly to the single currency; membership of the strong euro has removed the danger of currency crises in indebted countries such as Greece.

Also, although the European Union does not guarantee the government debts of its members, markets see an implied guarantee -- they think the EU would probably find some way to assist those countries if debt burdens became too heavy.

German finance minister Peer Steinbrueck fuelled that belief in February by saying: "If it came to a serious situation, all of the euro zone countries would have to help."

The result is a "ringfence" around the euro zone which is sheltering countries from some of the worst consequences of rising public debt, and is working better than many analysts predicted when the euro zone was created.