The government is facing a last ditch effort to stare down the markets amid signs the sovereign debt emergency will force it to force the announcement of the final bill for Anglo Irish Bank as soon as this week.
The "see who blinks first contest" will likely push the government into the sale of the multi-billion euro National Pension Reserve Fund, analysts said, if the state is to avoid an EU-IMF bailout fund.
The government failed to settle last week's turmoil on the debt markets, and senior analysts said new rumours about the costs of saving the banks, not only Anglo but AIB too, were the main reason that Irish sovereign interest rates soared to new record highs this weekend.
The markets were already spooked that the announcement about the Anglo Irish costs – originally penned for the next fortnight – would exceed their worst fears.
The government briefed scores of international analysts that the overall banking and budget deficit this year would set a new European record on the same day that new rumours about the health of Irish banks surfaced.
Chris Pryce, the lead analyst for Ireland at Fitch Ratings, said he had been told that the government was prepared to do whatever it took and would pay "1% or 2% or maybe more" than the assumed 5% rate it would face if it accepted the bailout cash. "The stakes are certainly high," Pryce said, likening the government's predicament with the markets to a "staring competition". But Pryce added that the differences with Greece of six months ago were "sufficiently great" for the credit ratings agency to believe that Ireland would not drop into the EU's bailout fund.
But leading market participants across Europe said the Irish government had failed properly to sell the message. Luca Cazzulani, a debt strategist at UniCredit in Milan, warned the government would need to improve its communications to halt the slide. "It will have to do something quite radical if it is to regain the trust," he said.
Announcing the sale of the unencumbered €14bn worth of stock market investments inside the National Pension Reserve Fund will be a key card for the government to play, said Professor John FitzGerald, director at the Economic and Social Research Institute, adding that economic growth will be much stronger here than the markets currently expect.
Ciarán O'Hagan at Societe Generale in Paris, which helps market Irish bonds for the government, said selling the pension fund would "be a very good surprise" for the bond markets even though the government had enough cash to see out the market crisis. "It makes no sense for the state to run a hedge fund when it has to borrow at 6%. It should be run down as soon as possible," O'Hagan said.
Analysts say the 6.25% rate – almost exactly the market price Greece was paying last January when people first talked about the country needing bailout cash – reflected fears that the costs of recapitalising the Irish banks would escalate further.
Gabriel Stein, chief international economist at Lombard Street Research in London, said the government here faces a "big presentational problem" in selling the markets the Anglo costs. "It boils down to what they should have done earlier. They should not have tried to keep Anglo Irish going as a going concern as they did in the spring," said Stein.
Dietmar Hornung, the lead Ireland analyst at Moody's in Frankfurt, said Eurostat rules had forced the government to bundle the overall banking costs into this year's accounts. "It does not change my analysis. But I acknowledge [the deficit] will be quite a high number and there is indeed some uncertainty that some investors will take it just at face value," without examining what is behind the figure, he said.
Pryce estimated that the overall deficit, including the banking costs, would reach between 22% to 24% of GDP this year. "It would be a peacetime record in Europe but, as I said, Ireland has had an exceptionally rough time of it."