German Chancellor Angela Merkel said that Greece is taking theright steps to get its next bailout payment, warning againstallowing a Greek default because of the risk of contagion for othereuro-area countries.

Merkel, in a German radio interview broadcast today, said thatan “uncontrolled insolvency” would further roil markets spooked bythe prospect of a Greek default. The euro region currently has nosystem for “orderly” insolvency until the permanent rescue fund isestablished in 2013, she said.

“The top priority is to avoid an uncontrolled insolvency,because that wouldn't just hit Greece and the danger that it hitseveryone, or at least a number of other countries, is very big,”Merkel told Berlin-based broadcaster Inforadio. “I have made myposition very clear: that everything must be done to keep the euroarea together politically, because we would very quickly face adomino effect.”

Merkel's comments are a rebuff to calls by members of her rulingcoalition to consider allowing Greece's insolvency and exit fromthe currency union as it struggles to satisfy the terms of its aidpackage. They also belie government plans to support German banksin the event that Greece goes into default.

The interview, posted on the website of the chancellor'sChristian Democratic Union party, is “typical Merkel,” HolgerSchmieding, chief economist at Joh. Berenberg Gossler & Co.,said by telephone from Hamburg.

Interview 'Tone'
“It does not completely ruleout an orderly default, except that the entire tone of theinterview very clearly suggests that her position is that sheexpects Greece to qualify for the next tranche,” he said. That shementions the European Stability Mechanism allowing for orderlydefaults from 2013 “suggests that she does not expect Greece todefault now.”

Greece's 10-year bond yield rose 48 basis points, or 0.48percentage point, to 24.03 percent as of 10:26 a.m. in London,after earlier climbing to a euro-era record of 25 percent.

“Everybody should weigh their words very carefully,” Merkelsaid. “What we don't need is unrest in the financial markets. Theuncertainties are big enough as it is.”

Philipp Roesler, the vice chancellor and economy minister whoheads Merkel's Free Democratic Party coalition partner, said in anop-ed published in Die Welt newspaper yesterday that there can beno “taboos” when considering action “to stabilize the euro in theshort term,” including a Greek insolvency.

Finance Minister Wolfgang Schaeuble, a CDU member like Merkel,denied that Roesler was calling for Greece to be allowed to go intodefault.

'Catastrophe' Planning
“He didn't put theplan on the table, he said you can't rule anything out,” Schaeublesaid in an interview with ZDF television late yesterday.“Considering every possible variation, you never rule outeverything,” he said. “A government has to consider what shouldhappen in case of a catastrophe.”

German coalition officials stepped up their criticism of Greecelast week after a delegation from the European Commission, EuropeanCentral Bank and International Monetary Fund suspended a report onprogress made in Athens in meeting the terms of its rescue program.The delay threatened to derail the next payment to Greece due nextmonth.

Merkel offered her backing for Greek Prime Minister GeorgePapandreou's government, saying that a team of officials from thethree institutions is returning to Athens this week, which“suggests that Greece has taken care of a few things” to meet thebailout conditions.

“Everything I hear out of Greece is that the Greek governmenthas hopefully seen the writing on the wall and is now doing thethings that are on the agenda,” she told Inforadio.

Merkel's “entire tone is that she is encouraging Greece to dowhat it takes and if Greece does what it takes, the next tranchewill be paid,” said Schmieding.

While she leaves open a back door to possible Greek insolvency,“the escape clause is not the message,” he said. “The message isshe will not expect an escape clause to be used.”

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