Euro zone: Steps forward, steps back

By Mike Peacock
April 27, 2012

Steps forward and steps back…

The Netherlands’ fractured political class managed to unite enough last night to reach a deal on a 2013 budget which they say will cut the deficit to 3 percent of GDP as required by new EU fiscal rules. Failure could have undermined the EU fiscal pact before it was even born and undermined the efforts of Italy and Spain to pull clear of the debt supernova.

Shortly afterwards, Standard & Poor’s  put the boot in by downgrading Spain two notches to BBB+, saying it could cut the rating further. Most tellingly, it cited the increasing likelihood that the government will have to provide further funds to the banking sector which is beset by property bad debts. Madrid insists it will not have to do so, nor will it look to the euro zone for help. Something will have to give since there is no prospect of troubled banks raising capital themselves.

However, S&P did note the structural reforms already undertaken which should support growth in the long-term and the fact that the ECB’s three-year money operation had reduced the banking risk for now.

Plenty of grist for follow-up today with S&P analysts holding an afternoon teleconference and Spanish data on retail sales, unemployment and inflation all due this morning  – none of which is likely to paint a pretty picture.

Maybe the biggest setpiece is the Italian bond auction of up to 6.25 billion euros of five- and 10-year bonds and two other niche issues. 10-year yields are expected to leapfrog 5.5 percent at the auction – up more than half a percentage point from the last such sale a month ago; no surprise given where the secondary market now is. But at that return, demand should be solid. Longer-term paper is often trickier to sell, given the greater uncertainty built in to the timeframe, and generally requires more foreign buying. The Italian treasury has put a wide target range of 3.75-6.25 billion euros on the sale to reflect that.

With French and Greek elections looming, the ECB apparently sitting on its hands, the euro zone slipping back into recession and Spanish and French debt to be sold next week, it doesn’t look like there’s going to be any let-up.

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