One knee-jerk reaction to Italy’s shock election was to worry about contagion to Spain. As Rome’s bond yields shot up last Tuesday, Madrid’s were dragged up in sympathy. These are the two troubled big beasts of the euro zone periphery and an explosion in either of them could destroy the single currency.
But Spain, where I spent part of last week, probably won’t catch Italian flu. True, the risk of Madrid being thrown off its reform path has risen since Italy’s inconclusive election. But Prime Minister Mariano Rajoy doesn’t have to face the voters for nearly three years. What’s more, the Italian vote may make euro zone policymakers less keen on austerity and so give Spain a better chance of returning to growth.
Indeed, investors have already started having second thoughts. By Friday, Madrid’s 10-year bond yield had fallen back to 5.1 percent from 5.4 percent on Tuesday. The spread between Spanish and Italian yields has shrunk to 0.3 percentage points. There’s even a chance that Madrid could enjoy lower borrowing costs than Rome in the coming weeks if Italy’s political paralysis shows no sign of resolution.
There is, of course, no cause for Schadenfreude in Madrid. The same factors that led to a stunning breakthrough in the Italian elections for the populist Beppe Grillo could eventually play out in Spain, albeit in a different way. Spain’s traditional ruling parties – Rajoy’s centre-right People’s Party and the Socialists – are discredited by a mixture of recession, 26 percent unemployment and corruption allegations. They each enjoy support of around 25 percent in the opinion polls, while the electorate’s trust in politicians has continued to plummet.
Spain doesn’t have a Grillo. But it does have radical left and centrist parties, each with roughly 15 percent support, as well as strong nationalist movements in Catalonia and the Basque Country. Unless there is an economic turnaround, nobody will have a majority in Spain’s next parliament and the country could be hard to govern.