Spanish waiting game

By Mike Peacock
October 22, 2012

Spanish Prime Minister Mariano Rajoy secured an overall majority in regional elections in Galicia over the weekend but in the Basque country, the nationalists were the big winners. These polls have been identified as one reason why Rajoy has held off asking for sovereign aid and Catalan elections still loom next month. Rajoy is likely to have to offer politically poisonous pension reforms in return for outside assistance.

So far, we seem to be no closer to a bailout request, which could then trigger European Central Bank intervention, and with 10-year yields having dropped more than two percentage points from a 7.5 percent peak since Mario Draghi’s vow to do whatever it takes to save the euro, one could reasonably ask why Madrid should be in a hurry. Some officials are saying Spain could quite comfortably wait until the turn of the year, leaving a prolonged period of limbo.

The fact is that if market pressure comes back on, Spain can quickly approach the euro zone’s ESM rescue fund for help and the ECB can pile in thereafter. So what has happened is that a bit of fear has been put back into investors intent on shorting the euro zone periphery to their hearts’ content; fear that wasn’t there until recently. It looks increasingly likely that Madrid would seek a precautionary credit line from the ESM, with conditions attached, which in theory could allow the ECB to buy Spanish bonds without the government actually taking money from the rescue fund. That would be a much easier sell politically.

In the meantime, the government’s assertion that it can comfortably fund itself through the end of the year looks plausible. That doesn’t rule out pre-emptive action though. On the financing front, the same applies to Italy. Having achieved bumper sales of its bond aimed at retail investors, it will now slash the amount of debt issued up to the year-end.

Last week’s EU summit certainly showed any panicky sense of urgency has evaporated although progress was made on step one of the banking union. As usual, however, what is agreed at summits is as likely to fray at the edges as to be pushed forward, so the proof will be in the eating. Taken at face value, it looks like cross-border banking supervision and therefore the ability of the ESM rescue fund to recapitalize banks direct could be in place by the middle of next year. But Germany still seems to want to go slower and what Germany wants… There was also no clarity on how banks long in trouble will be dealt with, given Angela Merkel’s insistence that there will be no back-dated recapitalization.

For this week, top billing probably goes to Draghi entering the lion’s den when he visits the Bundestag to address German concerns about potentially open-ended bond-buying. The Bundesbank remains fundamentally opposed although Merkel is much more sanguine.

On the macro front, we get flash PMIs for the euro zone, Germany and France as well as the German Ifo on the same day. What has been noticeable is that these survey data have been notably more gloomy than the hard statistics. Germany now expects to grow by no more than 1 percent this year and next. But it’s still growth. Britain, in contrast, has already contracted for three consecutive quarters. It should bounce back in Q3, figures for which are due in the coming week, largely for technical reasons, dragging it out of recession but the story of little or no growth is set to persist.

Stock markets have started the fourth quarter in bullish form despite the lack of euro zone clarity and have made some startling gains in what was billed as a grim, even threatening year. Similarly, euro zone bond yield spreads over Bunds are at their lowest in several months. Can that last? Maybe it can, given the ECB has made that market a two-way bet again.

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