At the time of writing the EU summit was coming to an end in Brussels and there had been no showpiece event like an aid request for Spain. The chief outcome has been an agreement with Europe’s leaders that the ECB will eventually be the single body responsible for all banking supervision in the Eurozone. There is no concrete time table to bring in this uber-banking regulator and there was no commitment to finalise either the date of implementation or exactly what the supervision will entail. For example, will large financial centres like Paris and Frankfurt be under more scrutiny compared with small centres like Finland and Austria? It is difficult for the markets to react to this summit as there is only scant detail and the impact of a banking regulator will be felt in the long term and thus only have a limited market impact right now.
The other development from the summit was Germany solidifying its opposition to using the ESM (the EU500bn long term rescue fund) to directly re-capitalise the banks in Europe. There was some expectation that Germany could allow this to happen, which would essentially ease the strain on sovereign finances from bailing out bad banks, particularly for Ireland and Spain. It became clear yesterday that Germany would not agree to this; for one if the ESM did inject money into the banks would that leave all Eurozone taxpayers holding the liability, and potentially the cost, of future bailouts? For now, Germany is keeping bad banks a domestic problem. Chancellor Merkel has been accused of playing politics at this summit and refusing any further cash injections until German elections are over next year. This surely means that Spain should get an aid request in quickly?
On that note, Spain already has a banking bailout of EU100bn. It is unclear at this stage if Germany’s resistance at the summit means that the Spanish state has to guarantee that money, which could weigh on state finances. Late on Friday the Spanish 10-year bond yield did start to rise, although it remained 40 basis points lower compared to the week prior and well below the critical 7% level. However, the news out of Spain this week has not been good. Its bad loan ratio has risen to 10.5% - another record high, thus the EU60bn recapitalisation as recommended in its last round of banking sector stress tests may not be enough if the bad loan rate continues to rise in the coming months. Thus, the outcome of this summit may have long term negative ramifications for Spain if it sees continued upward pressure on its bond yields, as this could push Spain closer to applying for a formal bailout, which may not be forthcoming from Berlin.
Spain’s regions will be in focus this weekend as regional elections take place in the Basque country and in Galicia on Sunday followed by one in the important state of Catalonia in 4 weeks’ time. If there are heavy losses for Rajoy’s Peoples’ Party it may spook markets as it may mean that the government might find it tougher to reign in regional public spending, which could threaten fiscal targets for this year. There is already some concern that the regional bailout fund set up by the central government is not enough at EU18bn to deal with all of the regions in trouble. Some think Spain may now wait until the next finance ministers’ meeting in mid-November before making a request for a credit line that would trigger the ECB’s OMT programme, however if regional finances continue to deteriorate then a full bailout may be waiting in the wings.
Overall, the EU summit does not alter the current state of affairs for Spain, but in the long-term it could have negative ramifications for Madrid, which could weigh on its bond market and hurt the euro.