As day follows night, a full-blown bailout of the Spanish state looks all but inevitable at this stage.
Yields on the benchmark 10-year bond are at 7.55%: well past the 7.00% tipping point that led Greece, Portugal and Ireland to send up the white flag. Regional governments in both Valencia and Murcia have requested aid from the Madrid central administration meanwhile, with up to five more waiting in the wings to do so.
In addition, public patience with austerity is running thin, with protests across Spain involving tens of thousands of people taking place across the weekend (of which I was a witness, I might add.) Given that, if a full-blown bailout of Spain isn’t due this week, it will be soon.
So what led us to this point, and how might it affect the foreign exchange rate?
Austerity Erodes Confidence
Spain’s biggest problem is that the very measures it’s implemented to boost confidence have had the opposite effect.
Prime minister Mariano Rajoy’s announcement of €65 billion in additional spending cuts a fortnight ago, for instance, was intended to signal Spain’s commitment to both austerity and the euro. Instead, the cuts have condemned Spain to what Rabobank analyst Richard McGuire calls a “death spiral,” as cuts reduce tax revenues paving the way for more cuts. “Front-loaded austerity is likely to deepen and prolong the recession,” writes Christian Schulz, an analyst at German bank Berenberg.
In the face of this, Spain’s government is fatalistic. Budget minister Cristobal Montoro for instance notes: “These steps are not negative, they simply seek to lower the deficit, because there is no alternative to lowering the deficit.” It’s as though the government doesn’t consider itself responsible for its actions: as though, because of Eurozone mandate or whatever reason, the cuts must happen, and damn whatever happens to the economy as a result. It’s not their fault, because it’s not their choice.
Strangely then, we have a situation in which Spain’s government looks to outside institutions to help Spain, rather than examine its own actions. Spain’s foreign minister José Manuel García Margallo said over the weekend: “Somebody has to bet on the euro and now, given the architecture of Europe isn’t changed—who can make this bet but the ECB” [European Central Bank.] This isn’t passing the buck so much as a belief that, having done what’s needed inside Spain, some outside institution must take the reins.
Unfortunately, the central bank President Mario Draghi is committed to battling inflation, and won’t intervene again to compensate for the shortcomings of Europe policy makers. He told Le Monde at the weekend: “Our mandate isn’t to solve the financial problems of states, but to ensure price stability…” Hence, Spain’s confidence that the rest of the Eurozone will come to its rescue is quite misplaced
Spain’s Perfect Storm
This then has created a perfect storm for Spain, wherein it does what’s required of it to keep the Eurozone intact, yet the framework to support it just doesn’t exist. Given that, is it any wonder yields have reached 7.55%? That, of course, is an unsustainable rate, which is why a full-blown bailout for Spain looks so on the cards this week.
As for the pound meanwhile, this loss of confidence in Spain has been accompanied by the market abandonment of the euro. The common currency reached its lowest points against the Japanese yen and Australian dollar since it was launched this week, as well as its lowest point against the pound since the collapse of Lehman Brothers in 2008. Without some miracle to help Spain, that looks set to continue.
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