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Nordea: Spanish aid request a step closer

October 11, 2012
While everybody was waiting for Moody’s decision on the Spanish rating, Standard & Poor’s was the one firing the next bullet. Still, the S&P 2-notch downgrade to BBB- just left Spain within investment grade, albeit with a negative outlook.

S&P cited the deepening economic recession, rising unemployment likely intensifying social discontent and frictions between the central government and the regions, and the policy setting framework of Euro-zone governments that is still lacking predictability.

An important factor had been the recent statement from the German, Dutch and Finnish finance ministers that the European Stability Mechanism (ESM) could not be used to recapitalize banks directly due to problems with the so called legacy assets, which the S&P read to mean that the costs of Spanish recapitalizations could not be later moved to the ESM. S&P had previously expected they would be.

The negative outlook, in turn, reflected the S&P’s view of the significant risks to Spain’s economic growth and budgetary performance, and the lack of a clear direction in Euro-zone policy.

As the rating was still kept in investment grade, the news could easily have been worse. However, the S&P action increases the chances Moody’s will soon strip Spain of its investment grade rating, and even worse that two rating agencies could soon put Spain in the junk rating category, which would increase the forced selling likely to occur in response to a junk rating.

Moody’s is expected to make its decision during October, and it will probably wait for the EU summit conclusions on 18-19 October. Unless it is confirmed that the costs of the Spanish bank recapitalizations could in fact be moved to the ESM later, Moody’s is very likely to downgrade the Spanish rating, especially as it sees a notable risk of the costs of supporting the Spanish banking system rising above the official estimates.

Meanwhile, calls for independence in Catalonia seem to be growing ever louder. Comments by Spain’s education minister yesterday that Catalan students should be Hispanicised (i.e. putting more emphasis on Spanish language and history education in Catalan schools) so they would feel as proud to be Spanish as they do to be Catalan will only increase tensions in the region. Catalan is the dominant language in Catalonia.

According to a recent poll, 74% of Catalans want a referendum to take place. Before any such referendum, Catalonia will have elections on 25 November, which will be followed closely. Even before that, the popularity of the Spanish government will be tested in the vote in Galicia and the Basque County on 21 October, which is seen as one of the dates Mr. Rajoy wants to get passed before making any aid request. The situation in Catalonia thus continues to be one of the many matters giving headache to Mr. Rajoy.

Yesterday’s news should put some pressure on Spanish bonds again, and as it seems higher yields are what it takes to convince Spain to make the very expected aid request, such a request is now a step closer. Still, with the ECB ready to start buying, it is understandable that many are reluctant to take a very negative view on Spanish bonds. That said, the patience to wait is always limited.

Spanish yields likely to move higher again from these levels

Company — Spain
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