Spain’s bond auction masks austerity dodge

European governments seem to be wavering in their commitment to cleaning up their debts. Spain looks likely to require further bailouts and the French and Italians are shying away from austerity plans.

The eurozone economic and financial crisis rolls on and on and on.

The most recent instalment of the so-called Lesser Depression in Europe, that could well continue for another decade, is the decision of the European Central Bank to leave its policy interest rate unchanged at 0.75 per cent. This was not a surprise. Clearly there is not much room on the downside to cut although there is still an expectation that the ECB will, at some stage, reduce the rate to 0.5 per cent in its efforts to do "whatever it takes” to engineer an economic recovery.

The ECB’s interest rate does not have much to do with broad borrowing costs within Europe given the ECB's recent decision to purchase bonds when requested from member governments. Whatever the problems in the eurozone, the level of the interest rate is not one.

On the list of worry for Europe are the political games being played by the leaders of the countries that seem to be in the most trouble.

For purely domestic political reasons and with only passing regard for economic risks, Spain’s Prime Minister, Mariano Rajoy, is holding off what will be an inevitable requirement to go cap in hand to the European Central Bank for assistance. Rajoy is shying away, it seems, from the harsh fiscal conditions that need to be met by Spain for it to get access to the bailout funds.

Those conditions involve Spain embarking on a fresh round of spending cuts and a tightening of tax policy. As things currently stand, Spain has a borrowing program of €207 billion next year, a level that will see government debt exceed 90 per cent of GDP. From these horrendous snap-shots of Spain’s government finances, it is a question of when and not if Spain will need to tap the ECB's bailout money.

There was also a bond auction in Spain overnight that saw €4 billion issued. The auction was at best fair, with yields around 10 basis points higher than at the previous bond auction last month. From the markets perspective, it was of some comfort that the auction was over-subscribed.

Rajoy’s baulking at taking the steps necessary to get the bail out funds has been accompanied by public intransigence from Italy’s Prime Minister Mario Monti, who is suggesting that the fiscal tightening already in place is austere enough to see the European Central Bank and IMF provide funding to the problem governments. While Italy’s problems are not as severe as in Spain, the market is betting that it too will need to go to the ECB for funding assistance in the not too distant future.

Overnight, Australian time, European Central Bank President Mario Draghi gave confirmation that the ECB had "everything in place” with the Outright Monetary Transactions the mechanism from which the bailout funds will be made available. Draghi also suggested that Spain has made significant progress in dealing with the fiscal problems, a comment no doubt designed to calm increasingly skittish markets.

Greek Prime Minister Antonis Samaras added to market nervousness, repeating his comments that Greece would ask the ECB for more time to repay its debt and that it wanted more concessions as it negotiated the conditions for the next instalment of financial assistance. The implied admission from Samaras that the fiscal problems in Greece remain acute was not well received by the European Central Banks Draghi who said that extending the duration of the debt beyond three years for any sovereign was not allowed for in the ECB rules.

The IMF has also warned that the Greek government would need to address its debt issues for it to receive additional loans and other financial assistance. The central piece of this was a commitment of the government reduce its debt from a likely peak of 179 per cent of GDP in 2013 to 120 per cent of GDP by 2020.

At the same time these trends were unfolding, Cyprus also requested bail out funds of €11 billion to address its fiscal problems, including recapitalising its banks and covering some recurrent government expenditure. This €11 billion is a hefty 62 per cent of GDP.

Amid all of this news, Rajoy, Monti and French President Francois Hollande are meeting tonight to discuss the financial issues within Europe including a possible timetable for Spain to tap the ECB's OMT.

As seems to be the norm now, markets will watch any developments with an eagle eye for any missteps, progress or to see whether nothing has changed. This saga is likely to roll on for a long time with snippets of news, like those outlined above, coming thick and fast almost on a daily basis.


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