Catalonia must have been hoping that Spanish government officials spent their summer break tanning on Barcelona beaches, because no sooner has European summer vacation finished, than it hit them up for an unexpected €5 billion bailout tab.
As the third and largest of the Spanish regions to ask for a handout, Catalonia's request prompted much speculation overnight that Spain may soon need a full bailout.
At the same time, Spain was hit with more bad news as it was revealed that the economy shrunk by more than expected in the second quarter. Official figures released yesterday showed that Spain’s economy contracted by 0.4 per cent in the three months to June. This follows a 0.3 per cent fall in the previous three months.
The latest developments will make it difficult for Prime Minister Mariano Rajoy to resist calls to request a full bailout. In June, Rajoy requested a €100 billion bailout for Spain’s flailing banking sector, which continues to struggle with toxic loans and a property market bust, but he stopped short of a full bailout for the country over fears of ceding sovereignty to Brussels.
Despite this, speculation that the country will have no choice but to request a full bailout has not gone away. Rajoy is only delaying the inevitable as he awaits next week’s ECB meeting, which is likely to focus on the possibility of the central bank aiding indebted countries by buying up government bonds.
Contributing to negative sentiment surrounding Spain was the revelation that deposits in Spanish banks fell 4.7 per cent in July, to €1.51 trillion. Investors pulling money out of the state’s banks is another blow for the country as it struggles to cope with crippling recession. And if Spanish savers have little confidence in their banks then any bank bailout becomes that much more expensive.
Unfortunately for Spain, it is being led down an austerity path that promises to result in a vicious cycle as higher taxes and negative sentiment over its ongoing recession result in reduced economic activity for the country.
The reaction to the raft of negative news was reflected in the higher bonds yields seen overnight. The country’s 10-year yield rose nine basis points to 6.47. While not at the record highs seen a few weeks ago, the rise shows the market is nervous over Spain’s ability to repay debt.
And where Spain goes, Italy follows. Italian bond yields were also higher overnight, climbing 11 basis points to 5.82 per cent.
For now, it is almost an inevitability that Spain will have to seek a full bailout. The only question is when. We probably won’t have to wait too long before Rajoy goes cap in hand to Brussels for a second time.
Any request is likely to come in the next few weeks, but with the permanent bailout fund still not in place, Rajoy may have to settle for funding from the bloc’s temporary bailout fund, the European Financial Stability Facility. Before he makes his decision, Rajoy will be eyeing next week’s ECB meeting, where a decision on measures to aid indebted eurozone countries will be made.
The markets will be hoping that the ECB steps in to reduce borrowing costs by buying up bonds off struggling countries. Earlier this month, ECB President Mario Draghi confirmed that the central bank may resort to buying government bonds as a means of reducing borrowing costs for countries including Spain and Italy. But the proposal has received much criticism, most notably from the German Bundesbank who view the proposal as reckless.
So onerous is the task of finding a solution for Draghi, that he has declined to attend the most important event of the year for central bankers, the Jackson Hole summit in Wyoming. He would have received no end of advice on what his options were there.
But some kind of intervention is required soon. If not, Spain and Italy’s borrowing costs will continue to rise to unsustainable levels, causing more risk for the zone.