Markets tanked this week as fears over Spain’s finances grew. The yield on Spanish ten-year debt reached 6%, up 1% in a month. In a bid to placate markets after an unsuccessful bond auction last week, the Spanish government announced additional cuts in health and education spending that were not in the recent budget. Spain aims to lower its budget deficit from 8.5% last year to 5.3% in 2012. Market jitters spread to Italy, where the benchmark stock index fell by 5% on Tuesday.
What the commentators said
After a four-month respite, the “crisis is on again”, said Larry Elliot in The Guardian. The European Central Bank’s (ECB) two huge injections of cheap loans to banks have proved to be merely “a large sticking plaster”. There may be much more liquidity in the system, but it hasn’t removed the dangers of insolvency.
The Spanish are caught in “a classic Catch-22”, said Buttonwood on Economist.com. They first agreed to a budget deficit target, then ditched it and went for a higher target, but have now added another batch of cuts to the budget. “Failure to meet the deficit target saps market confidence while austerity programmes designed to meet the target lead to recession, which also saps market confidence.” With ten-year yields at 6%, Spain’s implied borrowing costs are higher than it can cope with long term.
Spain’s second recession in three years is set to raise overall debt as a proportion of GDP. Unemployment is at 23%. Throw in harsh austerity, and highly debt-ridden households are hardly likely to up their spending and boost growth. The outlook for exports is also discouraging. To make matters worse, Spain showcased “the incestuous relationship whereby undercapitalised banks propped up sovereign borrowers who stood behind those same fragile banks”, said John Plender in the FT.
Spanish banks used cheap ECB loans to earn high interest rates on their government’s debt. But topping up bond holdings has made them even more vulnerable to a potential default. Furthermore, with yet more bank losses to come as house prices fall further and the recession kicks in, the higher the potential cost of a state rescue for the banks. “The weakness of government finances, the fragility of banks and worries about the scale of the recession all feed on each other,” said Nicholas Spiro of Spiro Sovereign Strategy. A fourth eurozone bail-out looks ever more likely.