Europe's backlash against austerity gained momentum, in achallenge to German Chancellor Angela Merkel's budget-cuttingprescriptions for resolving the debt crisis.

French President Nicolas Sarkozy lost the first round of hisre-election bid and a revolt against extra spending cuts in thetraditionally budget-conscious Netherlands propelled Prime MinisterMark Rutte's coalition toward an early breakup.

Together with anti-austerity rumblings in a campaign forelections in Greece, the shift in grass-roots sentiment at theheart of Europe generated fresh doubts about the German-drivenstrategy for getting to grips with the two-year-old crisis.

“We have organized the track of discipline, that's very good andwe have to continue on that, but we need desperately also toorganize the second track, the track of growth, solidarity,investment,” former Belgian Prime Minister Guy Verhofstadt, now amember of the European Parliament, said on Bloomberg Television's“The Pulse.”

The euro fell as bond investors moved money into Germany and outof the Netherlands, Belgium, Spain and Italy amid concern that aconsensus over the crisis response is fraying. The yield onGermany's five-year bond fell to a euro-era low of 0.61 percentwhile the premium that investors demand to hold Dutch bonds overbunds rose to the highest since 2009.

Political tensions coincided with a report of agreater-than-expected decline in services and factory output inApril, equipping opponents of austerity with evidence thatbudget-cutting zeal may cast the 17-nation euro region intorecession.

Northern European advocates of tight fiscal policies pointed toa separate report from the European statistics office showing thatthe aggregate debt of euro governments reached 8.2 trillion euros($11 trillion) in 2011, the highest in the currency's 13-yearhistory.

Merkel, who has dominated Europe's crisis response, said debtreduction is the best route to economic health.

“Solid budget management is a factor for producing growth, butof course not the only one,” Merkel said yesterday at the Hanovertrade fair, a showcase for high-tech products. “We're still in theprocess of overcoming this crisis.”

While that has pushed down German borrowing costs, otherEuropean countries are struggling to convince investors thatausterity is the best route to political stability and financialhealth. Ten-year bond yields rose 3 basis points to 5.94 percent inSpain today and 6 basis points to 2.37 percent in theNetherlands.

Sarkozy Trapped

The politician caught in the middle is Sarkozy, who sought tobalance the German anti-deficit line with pro-growth policies, anddelivered on neither count. France was stripped of its AAA creditrating by Standard & Poor's in January and had 9.8 percentunemployment in the fourth quarter.

While French bonds have since rallied, the risk premium on10-year debt at one point last year rose to the highest sinceFrancois Mitterrand was president in 1990. The spread over Germanbunds is now at 145 basis points compared with 190 in November.

Voters punished Sarkozy yesterday, making him the firstincumbent in the 54-year history of France's Fifth Republic to comein second in a presidential primary. He now faces an uphill climbin a May 6 runoff against yesterday's front-runner, Socialist rivalFrancois Hollande.

Hollande pressed the advantage today, telling a rally in Quimperon the Brittany coast that a Socialist victory would “be the end ofimposing austerity everywhere, austerity that brought desperationto people throughout Europe.”

Hollande has promised to renegotiate a deficit-reduction accordthat Merkel pitched to German voters as proof that Europe hasembraced fiscal rigor. The yet-unratified accord also helpedconvince the European Central Bank of governments' determination tostamp out debt.

In the final days of the campaign, Sarkozy's temptation is toreach out to backers of Marine Le Pen's anti-immigrant NationalFront, which tallied 17.9 percent in the first round, its bestresult ever. Such a tilt would distance Sarkozy from the Europeanmainstream if re-elected.

National Front

“What would the National Front mean: no euro, no Europe,”Luxembourg Foreign Minister Jean Asselborn, a Socialist, toldreporters in Luxembourg today. “If I were president of therepublic, I'd be asking myself why one in five French voted for theNational Front.”

A party that rejects immigration and bailouts for debt-riddencountries flexed its muscles in the Netherlands, one of fourremaining AAA states in the euro zone and a traditional enthusiastfor fiscal and wage restraint.

Geert Wilders, head of the Freedom Party, balked at socialsecurity cuts over the weekend, removing support for Rutte'sminority government. Rutte's Cabinet offered to quit today, puttingearly elections on the horizon. Queen Beatrix asked the Cabinet tostay as a caretaker in the meantime.

Credit-default swaps on Dutch bonds jumped 11.5 basis points toa five-month high of 130 at 3:20 p.m. in London, according to datacompiled by Bloomberg.

The chances of a Dutch political compromise “do not look veryhigh,” Riccardo Barbieri, chief European economist at MizuhoInternational Plc in London, said in a note to investors. “Germanylooks increasingly isolated within the euro zone due to its lowbudget deficit and stringent discipline-enforcing mechanisms.”

The Netherlands posted a deficit of 4.7 percent of grossdomestic product in 2011, the third year over the euro limit of 3percent, today's official EU data showed. Rutte needs to cut anextra 9.5 billion euros to meet the target by 2013. The economy islikely to shrink 0.9 percent this year, the EU forecast on Feb.23.

The rebellion against austerity among longstanding German alliessharpens the focus on elections next month in Greece, the epicenterof the debt crisis. The Greek poll, also on May 6, looms as areferendum on the budget cuts demanded of Greece in exchange forbailout loans now worth 240 billion euros.

Antonis Samaras, head of the New Democracy party, yesterdaypromised lower taxes and an end to the across-the-board pension andwage cuts that have triggered the steepest economic slump since theend of World War II. Budget savings will mainly come throughfighting waste, he said.

Samaras's party is on track to win between 104 and 112 seats inparliament, leaving it short of an outright majority to govern, apoll by Public Issue SA showed. As many as 10 parties may enter theparliament, the poll showed.

“What you've got, look right across the EU, is ananti-incumbency move,” said Richard Whitman, an associate fellow atChatham House in London. “Where publics have chance to expresstheir dissatisfaction with incumbents, they're giving incumbentsthe kicking.”

Bloomberg News

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