September 28, 2012 6:23 pm

Heat on Madrid to accept bailout package

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Spain is facing intensifying financial market pressure to accept a European bailout package after a surge in the country’s government bond yields this week.

Investors braced for a possible re-eruption of the eurozone debt crisis as the Spanish government on Friday unveiled the cost of recapitalising its banks after earlier unveiling another round of budget cuts and tax increases.

Spanish and Italian bond and equity prices rallied strongly over the summer after Mario Draghi, European Central Bank president, pledged to do “whatever it takes” to preserve the eurozone.

But Spanish 10-year bond yields pushed above the six per cent level this week as demonstrators mounted angry street protests against fiscal austerity in Greece as well as in Spain.

By Friday, the yields had fallen back below 6 per cent but were still significantly above levels at the start of the month when Mr Draghi set out in an ECB press conference details of a eurozone government bond-buying programme.

The ECB is demanding eurozone governments accept an economic programme drawn up by EU institutions – and possibly the International Monetary Fund – before it intervenes in their debt markets.

“If nobody in the European institutions takes the lead and basically exerts strong pressure on Spain to make the decision [to take a rescue package], you may well get into the situation where markets force the issue,” said Gilles Moec, European economist at Deutsche Bank. “We have started to see that beginning to happen earlier this week.”

Laurence Mutkin, fixed-income strategist at Morgan Stanley, said: “Throughout the eurozone crisis we have had this cycle of crisis-response-improvement-complacency. Because people were reassured by the [ECB’s] response, the pressure from the markets had fallen.”

Spanish two-year bond yields – which have become an indicator of investor sentiment towards the eurozone – ended on Friday up 27 basis points at 3.43 per cent compared with a week ago.

Eurozone tensions were further inflamed by a warning by Germany, the Netherlands and Finland stating plans to move bad bank assets off government books would not apply to “legacy assets” – apparently dashing Spain and Ireland’s hopes of being freed of billions of euros of debt incurred in bailing out their banks.

But investors have maintained faith in the ECB’s pledges of support, which have backstopped markets this week.

Spanish two- and 10-year bond yields remain substantially lower than peaks seen in July when the two-year yield almost hit 7 per cent.

“There is clearly slightly more market disquiet than there was two weeks ago but it is still less than it was two months ago,” said Mr Mutkin.

Meanwhile, French bond markets showed little reaction to the budget unveiled on Friday by the country’s socialist government, which hit big business and the wealthy and which analysts warned would slow growth.

Ten-year yields hovered around a two-week low of 2.2 per cent. But French share prices have fallen sharply this week with the CAC 40 index ending down 5 per cent compared with last Friday’s close.

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