Today in the euro zone – Bonds, strikes and firewalls

March 29, 2012

Big debt test for Italy which will sell 8 billion euros or more of longer-dated bonds. A short-term T-bill sale went okay on Wednesday but a day before, the secondary market reacted negatively to a sale of zero-coupon and inflation-linked bonds, pushing Italian yields higher.

The glut of ECB three-year money has ensured Italian and Spanish auctions have sailed out of the door so far this year but there will be no more largesse from the central bank so be on the look out for signs of that support fading. Analysts expect this sale to go well with Italian banks wading in again.

Euro zone money supply data on Wednesday showed Spanish and Italian banks stocked up on government bonds in February – and that was before the ECB’s second instalment of money creation to the tune of 500 billion euros. So bond sales should be underpinned for some time yet though it is clear that the central bank has bought policymakers time rather than solved the root problems.

Growing investor fears about Madrid’s public finances in recent weeks have pushed Spain’s benchmark 10-year yields above those of Italy.

Having ripped up a deficit target agreed with Brussels, the Spanish government faces a general strike on Thursday and will present its full 2012 budget on Friday. Protest has been distinctly muted so far, and opinion polls suggest the public are resigned to the necessity of austerity. But with at least two more years of pain to come as Madrid is forced to slash its deficit, that mood could snap at any moment, particularly if the argument that cutting while in recession will only create a downward spiral takes popular hold.

Given this backdrop, it is all the more important that euro zone finance ministers meeting in Copenhagen on Friday agree to increase the resources of their rescue fund in a way which markets and the IMF view as meaningful. If they do, the latter will embark on a fund-raising drive of its own, which could be used to defend euro zone weaklings. Again, this is buying time – and no more than that – for governments to push through structural reforms to make their economies more competitive and balance the need to cut debt while not snuffing out growth, a balancing act that has not been achieved so far.

Nor is this simply a southern European problem. The Netherlands’ fractious coalition is at odds over their budget and the need to cut the deficit in a so-called “core” euro zone economy which is already in recession. The Dutch have been very vocal critics of the Greeks and others. A case of hoist on their own petard? Budget talks resume today and the Dutch central bank also issues its annual report.

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