UNITED FRONT:  German Chancellor Angela Merkel and Spanish Prime  Minister Mariano Rajoy in Berlin on Monday. Picture: REUTERS
UNITED FRONT: German Chancellor Angela Merkel and Spanish Prime Minister Mariano Rajoy in Berlin on Monday. Picture: REUTERS

MUNICH — Europe’s political tremors risk spoiling the region’s market calm, with corruption allegations buffeting Spanish Prime Minister Mariano Rajoy and Italy’s Silvio Berlusconi narrowing the frontrunner’s lead as elections loom.

Mr Rajoy, facing opposition calls to resign amid contested reports about illegal payments, displayed backing from Chancellor Angela Merkel in Berlin on Monday as eurozone leaders schedule a flurry of meetings this week ahead of a European Union summit on Thursday and Friday. Last week’s nationalisation of the Netherlands’ fourth-largest bank and a ¤2.17bn loss at Deutsche Bank underscore the fragile economic health in the region.

"The euro crisis is not over," German Finance Minister Wolfgang Schaeuble said on Friday at the Munich Security Conference where fellow panellists included Deutsche Bank co-CEO Anshu Jain.

Still, "we’re in a much better position than we were a year ago," the minister said.

A sluggish economy, uncertainty over the outcome of this month’s Italian election and Mr Rajoy’s new troubles threaten to curtail the time won by politicians with the central-bank bond buying. For now, European policy makers have room to manoeuvre as borrowing costs for indebted nations have fallen and investor confidence returns.

Spanish bonds slumped on Monday, sending the 10-year yield up 22 basis points to 5.43%, the highest in seven weeks, in Madrid.

Italy’s 10-year bond yields climbed 13 basis points to 4.46% — still almost three percentage points below its 2011 eurozone record. The euro fell 0.6% to $1.3559.

In Madrid, opposition leader Alfredo Perez Rubalcaba said Mr Rajoy should resign after reports in El Pais newspaper that he or members of his People’s Party received illegal payments.

Mr Rajoy said at the weekend that the allegations were unfounded and stemmed from unknown people trying to damage his party.

"It’s false, I have never received or shared out illegal payments within the party or anywhere else," Mr Rajoy said. El Pais had reproduced what it said were handwritten extracts from ledgers detailing payments to party officials, including the prime minister.

Mr Rajoy has imposed harsh austerity measures in Spain’s democratic history to curb the budget deficit and lower borrowing costs.

In Berlin, Ms Merkel backed Mr Rajoy, saying, "I’m convinced that the Spanish government and Mariano Rajoy as prime minister can resolve this task — and Germany will assist him with all of our strength."

In Italy, a February 1 poll showed billionaire media magnate Mr Berlusconi closing the gap with leader Pier Luigi Bersani to five percentage points, as he undertook a media blitz. The surge by Italy’s former premier, who was forced to resign in 2011 amid soaring bond yields, threatens Mr Bersani’s ability to win a majority even if he remains ahead in the polls. Mr Berlusconi has pledged to refund a tax on primary residences imposed by his successor, Prime Minister Mario Monti. Voting takes place on February 24-25.

"Berlusconi wants to buy the votes of Italians with the money that Italians had to turn over to cover up the shortfall left in the public accounts by Berlusconi, who governed for eight of the past 10 years," Mr Monti said on Monday.

"The markets have saluted" developments in the eurozone, French President Francois Hollande said at a meeting with Mr Monti in Paris on Sunday.

Deutsche Bank’s Mr Jain lauded Germany’s pro-austerity policies and the European Central Bank’s commitment to limitless bond purchases as catalysts for bringing the 17-member currency past the "acute" stage of the crisis. "Thank God, the acute phase of the crisis is over because we were flirting with the edge of the precipice for entirely too long," Mr Jain said at the Munich conference.

The European banking landscape dimmed further when the Dutch government took control of SNS Reaal for ¤3.7bn after real-estate losses brought the lender to the brink of collapse. The lender had been left struggling to repay the bail-out before next year’s deadline.

"Banks still are a very weak link in Europe’s recovery," said Bas Jacobs, a professor of economics at the Erasmus University of Rotterdam. "Not enough losses have been written off. Eurobanks with impaired balance sheets become zombie banks, which reduce lending to make up for those losses."

Teetering banks are also the central issue in a bail-out for Cyprus, which will be the eurozone’s fifth. As European leaders hold off on a rescue agreement for Cyprus, a report cited by Nicosia-based broadcaster Sigma placed the worst-case scenario for recapitalising the country’s lenders at ¤9.2bn. That would make the country’s debt unsustainable, Sigma reported on Monday, citing a Pimco report.