Down to size in Spain

Down to size in Spain
11/06/12 @ 07:04 GMT by Simon Smith, Chief Economist

The weekend bailout for Spanish banks has given some support to Asian markets and the single currency has also pushed higher to a 2 week high. It all comes down to size and whether this is enough to stem the tide of fear, but does not stoke it further. The talk is of a maximum of EUR 100bln, with auditors to come up with a more accurate figure for recapitalisation in the coming ten days. But for all their number-crunching, politics and the underlying economic assumptions will shape the end figures. For if the final number is on the large side, this creates the fear that the issue is much bigger than feared. Conversely, a figure too small will mean the relief will be short-lived as the next capital injection is sought. Furthermore, whilst welcomed, this still fits in the fire-fighting category of measures, rather than a reform that will ensure the longer-term viability of the eurozone. For that, the focus remains on Germany, who for the moment are content to pursue the austerity and unilateral lines of fiscal responsibility

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Commentary

More clarity in China. After the rate cut on Thursday of last week, the latest data in China has offered further clarity on the state of the Chinese economy. There was a modest fall in the annual pace of retail sales in May, down to 13.8%, from 14.1% previously. Meanwhile, CPI data showed a further than expected fall in the headline rate, down to 3.0%, from 3.4%. This offers further confirmation to the perception that their focus has moved from inflation to stabilising the economy and ensuring that the slowdown does not turn into something more threatening.

Our broken world. And it has come to this – the distrust of banks in Europe is so dreadful that investors are now prepared to pay governments to return their money to them. Consider this: the Swiss 2yr yield is now -0.33%, the German 2yr yield are now essentially zero and dipped into negative territory last week, and the Danish 2yr yield is -0.08%. Even in high-debt Britain, the 2yr yield is just 0.24%. Rather than focus on returns on capital, investors in Europe are completely absorbed with the return of capital. These bank runs in the south of Europe are in serious danger of spreading northwards before too long. Balance sheet deleveraging and risk avoidance in Europe is now so pronounced that a destructive spiral of debt deflation is underway in many parts of Europe. Even after the Spanish bank rescue over the weekend, the impression given in markets is that Europe is hanging together on hope and a piece of string.

The skies darken once more. Friday ended with general disappointment in European markets. As well as the uncertainty over the Spanish banking situation, there was disappointment that the Fed Chairman did not give the go-ahead on additional QE, although the way things are going this may simply be delaying the inevitable. He may just be waiting until the next FOMC meeting on June 19-20 before making any announcement. Even so, notwithstanding China’s surprise decision to lower rates, markets were clearly expecting more from the major central banks this week than they got. As a result, the euro dropped sharply on Friday, back near 1.2450 after trading around 1.26 late on Thursday.