Europe may be heading back into debt storm

Europe may be heading back into debt storm

A flood of easy money courtesy of the European Central Bank made for a calm start to 2012, but a poor Spanish bond sale last week signals it may only have been a lull before the debt storm breaks, analysts warn.

The ECB injected roughly one trillion euros ($1.3 trillion) into eurozone banks at auctions in December and February, helping to ease concerns banks would face a funding crunch.

Some of this cash ended up in the sovereign bond markets, helping reduce the rates countries need to pay to raise funds after a year of high tension over whether Italy and Spain — the eurozone’s third- and fourth-largest economies — might also need to be bailed out after Greece, Ireland and Portugal.

The first three months of the year are important. as countries often try to meet a huge chunk of their annual borrowing needs at the outset, and they made the most of the early calm.

Spain covered 43 percent of its annual medium and long-term financing needs in the first quarter, taking advantage of rates of around 4.0 percent compared to near 7.0 percent at the height of the crisis late last year.

But in the first week of April, the calm on European debt markets abruptly ended.

Spain barely raised the amount it sought in a bond auction on Wednesday and had to pay investors sharply higher rates just after announcing a tough 2012 budget that aims to make a whopping 27 billion euros in savings.

Madrid’s warning that its public debt will jump by 10 percentage points this year to nearly 80 percent of gross domestic product (GDP) clearly rattled investors, who also faced the prospect of an economy slipping deeper into recession.

While ECB liquidity measures helped shield Madrid from immediate danger, economist Raj Badiani at IHS Global Insight warned the risks are expected to intensify next year as Spain is battered by recession, and high unemployment and bad real estate assets drag down banks.

This would make it difficult for Spain to achieve its target of reducing its public deficit to the EU ceiling of 3.0 percent of GDP by austerity measures alone, he said, and raised the possibility it would need some sort of help from its European partners.

However, ECB chief Mario Draghi made it clear on Wednesday that such a move was not on the cards, although the central banker would not rule out further action to support the region’s banks.

Bond yields of weaker eurozone states are moving higher, as did the gap with those of German government bonds, the benchmark measure.

The yield on Spanish 10-year bonds jumped to 5.735 percent from 5.332 percent at the end of March, with the spread with German bonds widening to over 4.0 from 3.54 percentage points.

The spread between German and Italian bonds widened to 3.67 from 3.31 percentage points.

France, which lost its coveted top triple-A rating from Standard & Poor’s rating agency earlier this year and faces concerns about the competitiveness of its economy, saw the spread on its bonds rise to 1.25 from 1.09 percentage points.

Elections in France and Germany may also raise concerns about changes to eurozone policy, and the threat of recession still hangs over the bloc.

The latest economic data present a grim picture, with German industrial output declining by 1.3 percent in February and a survey of purchasing managers suggesting a manufacturing slowdown and that the eurozone has gone into recession.