The going gets tougher for Italy and Spain

April 12, 2012

One trillion euros is a lot of money. And as we have previously noted on this blog it did a lot for stock markets early this year but not much for the real economy.

But recent bond auctions in the euro zone suggest the impact of two rounds of cheap 3-year ECB funding on the region’s struggling bond market may also be fading.

Italian three-year borrowing costs surged more than a full percentage point at an auction to 3.89 percent – its highest since mid-January.

Nick Stamenkovic, strategist at RIA Capital Markets says:

Clearly it shows investor appetite for Italian bonds even at the short end has diminished recently as the effects of the two LTROs (long-term refinancing operations) from the ECB dissipate.

That was not the only patchy bond sale recently. Italy’s one-year borrowing costs doubled at a sale of short-term bills on Wednesday and, just last week, Spain had to pay dearer to borrow through medium-term bonds.

The new jitters in the market have partly been fueled by Spain’s fiscal conundrum: austerity aimed at reducing its budget deficit risks choking off the very growth that is needed to repair the country’s fiscal position.

Against this backdrop, some in the market took solace from comments by ECB Executive Board member Benoit Coeure on Wednesday that the scale of market pressure on Spain is not justified given the reforms it has laid out and that the ECB still had its bond-buying programme (SMP) as an option.

John Davies, fixed income strategist at WestLB says:

Given the market is not giving a huge amount of credibility to the Spanish government’s actions because it thinks either the deficit is too high or growth is too weak … and given that the growth data for Spain is not suddenly going to get much better, I think the Spanish Tesoro will be keeping their fingers crossed that the ECB does take a more aggressive stance again.

Analysts at Société Générale believe the SMP is no longer enough:

Unfortunately, the SMP won’t be causing a U-turn. The threat of (bond) purchases of course can create occasional price corrections. But the SMP has been on and off, and no longer looks like a tool that can durably affect market conditions – unless the ECB radically changes its communication and commitment.

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