04 April 2012

WSJ: Spain's fate in the hands of the ECB

This article states that with an economy in recession, further austerity planned, yields rising and the fate of Spain's banks tied ever closer to their government, a crunch point may be approaching.

Spanish bonds continued to fall after the auction, with the bellwether 10-year yield rising to 5.7 per cent. While some of the move might be the result of thin trading conditions ahead of Easter, that is the highest since January 9 and more than a percentage point higher than the year's low. Italian yields were dragged higher in Spain's wake.

The big problem is that Spain is relying largely on its own banks to buy its bonds with money supplied by the European Central Bank. Spanish banks bought €39 billion of government bonds in January and February, versus €8 billion for German banks and €6 billion for French banks.

That ties the fate of Spain's banks more closely to the government, whose debt is rising at a rapid pace as the budget deficit remains high and the economy shrinks. Spain forecasts debt will be close to 80 per cent of gross domestic product this year, more than double the figure for 2007; the sharp deterioration is of more concern than the relatively modest level.

Spain has already raised 47 per cent of the funds it has targeted for this year, providing a cushion against the current market pressure. But Madrid is struggling to convince investors it can walk the tightrope between reining in its borrowing and choking off the recovery.

Spain's fate likely lies in the hands of the ECB, whose exposure to Spanish banks hit 15 per cent of the country's GDP by the end of February, according to JP Morgan. At some point, the ECB may put pressure on Madrid to seek eurozone help, in particular to recapitalise its banks, as it did with Ireland.

Full article

© Wall Street Journal