Rumours of a Spanish bailout (although denied by the ECB) worried the markets Friday and, together with news that gross borrowing by Spanish banks from the ECB nearly doubled in March, saw the yield on a Spanish 10-year bond jump 15.6 basis points to 5.976%. “Despite all the efforts of the new Spanish government, sentiment may not change unless fiscal execution and economic activity fall into line with government targets,” said Barclays Capital in its Global Economics Weekly report.
Focus will remain on the euro area over the coming week. Germany, France and most importantly Spain return to markets with government bond auctions. Given the role the last Spanish auctions played in unnerving markets, these will be closely watched. However, reduced size in Spain and short maturities in France and Germany should see these progress without too much hitch. Otherwise, German ZEW and IFO business confidence measures are released and provide the first of the euro area’s surveys for April. Lloyds TSB expect declines in both, although they will remain consistent with German expansion. Markets may fear that this will not be the case for other EU17 members. Attention will also increasingly switch to politics, with the first round of the French Presidential Elections to be held on Sunday week.
The Spanish sovereign bond market has been very sentiment driven in recent days. Spanish house prices have probably fallen about 30% from the peak and there are no signs of stabilisation. The lending rate that house purchasers face is rising despite the ECB’s 3Y LTRO. Losses in the banking sector related to real estate developers seem to have been taken care of with new provisions but additional provisions of possibly around EUR100bn might be needed on the rest of the Spanish banks’ loan books. Spain has repeatedly missed its fiscal targets and the autonomous regions have in particular failed to deliver the planned tightening. The Spanish government continues to target a deficit of 3% of GDP in 2013, which appears unrealistic. In a negative scenario where the banking sector needs a EUR100bn rescue package, the recession is prolonged and funding costs remain high combined with substantial fiscal slippage, Danske Bank calculate Spain’s government debt would peak around 110% of GDP. In Danske’s view a substantial part of the recent rise in sovereign spreads is merely a normalisation after a period of compressed spreads following the 3Y LTROs. The sudden moves in yields last week may also be attributed partly to a thin market. If we get closer to the edge again, the ECB may revive its Securities Market Programme or introduce another round of LTRO. A rescue package targeting the banking sector is probably the most likely outcome if Spain needs further aid.
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