05/23/2012 12:31 EDT | Updated 07/23/2012 05:12 EDT

Euro falls to near 2-year low

The euro fell today amid growing discussion that Greece would be forced out of the eurozone.

In mid-afternoon trading, it was down one per cent at under $1.26 US, and at its lowest point in 21 months.

Earlier, Germany’s central bank issued a report saying the effects of a Greek exit would be substantial but “manageable.”

As well, Reuters reported that eurozone officials had told the members of the currency area to prepare contingency plans in case Greece leaves.

European markets closed sharply lower with London's FTSE 100 index down 2.5 per cent, Frankfurt's DAX off 2.3 per cent and the Paris CAC 40 down 2.6 per cent.

Adding to the gloom, Spain’s Prime Minister, Mariano Rajoy, warned his government will run out of money if it is forced to continue borrowing at current high interest rates.

And markets remained pessimistic that a summit of European Union leaders underway in Brussels would come up with a solution to the region’s debt crisis.

Rajoy suggested the European Central Bank resume some of its emergency measures, such as buying the bonds of weak countries, which has the impact of lowering countries' borrowing rates.

He spoke in Paris with France's new president, Francois Hollande, at his side, saying he will push at the EU summit for eurobonds.

"Europe has to come up with an answer. It is a must, because we cannot go on like this for a long time, with large differences when it comes to financing ourselves. And it is because of these differences that the policies that we Europeans believe in, such as controlling government spending and reforms to encourage growth, ultimately have no effect," Rajoy said.

"So I am going to talk about liquidity, financing and debt sustainability. For me it is the most important thing today. There are a lot of important things but this is the most urgent one," he said.

Proponents of eurobonds say they could help mitigate the crisis by spreading debt risk across the single currency zone.

But the region’s strongest economy, Germany, has continually refused to dilute its own credit worthiness and back the idea of jointly-issued eurobonds.

But Rajoy said he didn't think the 27 leaders meeting in Brussels would resolve the issue of adopting Eurobonds during the one-day meeting.

Hollande also insisted he would stick by his push for a Europe-wide growth pact by the end of June.

The meeting takes place one day after the Organization for Economic Cooperation and Development warned that the 17 countries that use the euro risk falling into a "severe recession."

A Greek election slated for June 17 is widely considered to be a referendum on Greece’s continued membership of the eurozone.

The main concern is that political parties that are against the terms of the country's bailout package will win the election.

If Europe then cuts off its funding to Greece, the country may face a messy exit from the euro, raising concerns that other countries might follow.

Greece's Evangelos Venizelos, leader of the centre-left PASOK party, acknowledged in Brussels that "the situation is very fragile."

He said he hoped co-operation of fellow European leftists such as Hollande "will give the possibility to organize, to send a concession framework in the common interests of Greece and of the eurozone, a concession framework for stability, for growth and for social cohesion."

Earlier in the day, the president of the European Commission, Jose Manuel Barroso, said the EC will do everything it can to keep Greece in the eurozone.

But Barroso said the Greeks must abide by their commitments to the conditions for their international bailouts, which include continued cost cutting.

"The euro area has shown unprecedented solidarity to Greece and its people," Barroso said in a statement.

"Without this solidarity, Greece will not be able to return to growth and prosperity," he said.

Banks get more cash

Also on Wednesday, both Greece and Spain moved to shore up their troubled banks.

Greece's Financial Stability Fund said four of the country's leading banks would receive a €18 billion ($23 billion Cdn) capital injection to replenish reserves hit by the massive debt restructuring deal.

The amount will be split between the National Bank of Greece, Eurobank, Alpha Bank and Bank of Piraeus as part of a €50 billion ($64.5 billion) recapitalization plan to boost their liquidity levels and keep them in business.

That recapitalization plan is a key element of the second, €130 billion ($167.7 billion) bailout agreement that Greece had negotiated with the European Union and the International Monetary Fund last March to stay solvent.

Greek banks suffered massive losses following a writedown of their Greek government bond holdings this year. On top of the writedowns, Greek banks have also been hit by customers withdrawing their euro-denominated savings as they hedge against the country's possible return to its old devalued currency, the drachma.

And Spain's economy minister said the government will pump at least €9 billion ($11.6 billion) of public money into nationalized lender Bankia so it can meet new capital requirements.

The government is seeking to shore up Spain's banking sector against market fears about the country's financial health. A recession and an unemployment rate of nearly 25 per cent have left Spain particularly vulnerable to the eurozone's debt crisis.

Many Spanish lenders are heavily exposed to Spain's burst real estate bubble. Bankia is the worst off of all, with C32 billion in toxic assets, and the government has taken control of the lender.

Economy Minister Luis de Guindos told lawmakers the government is ready to provide further financial support when Bankia comes up with a recovery plan.