Euro exchange rate fails to gain after latest Spanish bond auction costs climb

The euro’s exchange rate remained flat in trading today, following the latest Spanish bond auction which saw costs climb with 10 year bonds sold at a yield of 5.743 percent, up from 5.403 percent in February and 2 year bonds sold at 3.463 percent.

The demand for the 10 year bonds was almost twice the amount sold.

“Overall, then, a reasonable set of results which will go some way to allaying fears the domestic bid [demand] for Spanish bonds has dried up.” said Richard McGuire, rate strategist at Rabobank.

There had been worries about this week’s bond auctions after the interest rates on existing 10 year bonds rose above 6 percent on Monday. Borrowing costs above 6 percent are considered by many analysts to be unaffordable in the long run.

“Until we see signs that the government is implementing the medium-term fiscal consolidation programme and signs of life in the Spanish economy, investors are going to worry about the trajectory of the debt to GDP ratio in the medium term,” said Nick Stamenkovic, bond strategist at RIA Capital Markets.

Too Big to Bailout

Analysts say Spain is probably too big for Europe to bailout. Its problems have added to ongoing worries about global economic growth.

Angst about the dire state of the Spanish banks increased overnight after fresh figures showed that their bad debts have climbed to the highest level in around 18 years. According to the figures from the Bank of Spain, 8.16 percent of the loans held by Spanish banks – or €143.8 billion ($US188.7 billion) – were at least three months late in their repayments in February.

Spanish banks have been hit with crippling losses on their loans to construction companies and property developers since the country’s massive real estate bubble burst in early 2008. But many predict that the banks’ problem loans will surge even further as the Spanish economy falls deeper into recession, and as housing prices continue to fall.

Figures released by the Spanish government overnight show that the fall in Spanish house prices is picking up pace. House prices in the first three months of this year were 7.2 percent down from their level a year ago, and 3 per cent lower than in the final three months of 2011. All the same, many analysts believe that Spain’s housing market remains overvalued, and that housing prices could suffer further sharp declines as the country falls deeper into recession, and unemployment pushes even higher.

Many critics argue that the ECB’s move to douse the European banking system with €1 trillion in cheap three-year loans has put the Spanish banks in an even more fragile financial position. Spanish banks were able to use the ECB money to play the ‘carry trade’. They borrowed from the ECB at a 1 percent interest rate, and earned a handsome profit by investing the money in high-yielding Spanish government bonds, and for a while this stabilised Spanish bond markets.

But investors are now worried that Madrid will fail to meet its deeper ambitious plans to reduce the budget deficit from 8.5 percent of GDP in 2011 to 5.3 percent this year.

As a result, they’ve been dumping Spanish bonds, which has pushed bond prices sharply lower and sparked fears that Spanish banks now face hefty massive losses on their bond portfolios.

The Big Question

As first quarter financial results are published, the official verdict for Spain is: back in recession. All signs of the very modest return to growth seen at the beginning of last year are gone and the shadow of the EU bailout now extends across the Iberian peninsula, with more and more predictions that Spain will soon join Portugal in needing rescue funds.

The big question from the beginning of the bailout operations, however, is whether the monetary union can withstand a bailout of a country of systemic importance and the size of Spain.

In March the eurozone finance ministers agreed on a long awaited combination of the two rescue funds – the temporary European Financial Stability Facility (EFSF) and the permanent European Stability Mechanism (ESM) with a joint lending capacity of 800 bn euros – not all of which is real available money.

Originally posted here:
Euro exchange rate fails to gain after latest Spanish bond auction costs climb