News that Spanish banks will receive up to €100-billion from existing European bailout funds initially spurred markets forward on Monday. The emergency aid seemed like real progress at first. After all, euro zone officials made the move quickly compared with their regular pace, and Spain didn’t need to agree to crippling austerity programs that some of its neighbours have had to sign on for in return for the cash.
But North American stocks held on to their gains for less than an hour on Monday, with investors clearly discerning something negative in the bailout.
Jonathan Loynes, chief European economist for Capital Economics, says there are suspicions that the full extent of banking losses in Spain have yet to be uncovered.
“Both Spain’s own position and the experience of other “bail-outs” raise clear questions over the extent to which the package will address the country’s problems,” he wrote in a morning note. “Meanwhile, the economic environment of sky-high unemployment and (still) falling property prices hardly bodes well for banks’ future profitability.”
He estimates that if Spain taps the full bailout (and it will need to), the country’s public debt-to-GDP ratio will rise to about 80 per cent, up from 70 per cent today. That level is manageable in normal times. But given the forecast for a lengthy period of weak economic growth in Spain and the rest of the euro zone, attempts to bring the deficit down are unlikely to be successful.
Mr. Loynes also doesn’t like the optics of the latest bailout. Ireland, Greece and Portugal had significantly more onerous conditions attached to their rounds of emergency funding. The discrepancy further erodes any sense of economic unity across the euro zone, he says.
Meanwhile, investors are fretting that Spain’s bailout positions Italy as next in line for emergency aid. Italy has significantly more debt than Spain, with its public debt-to-GDP ratio now at 120 per cent. Even though Italy isn’t suffering from the same crippling level of unemployment as Spain, the bond markets are treating the two countries with similar levels of caution.
The yield on Italy’s 10-year government bonds rose 25.9 basis points, almost as much as Spain’s 29.8 basis point increase on Monday. Investors are now receiving more than 6 per cent to hold Italian 10-year debt.