What Could a Spanish Bailout Mean for the Euro?

Word through the forex grapevine is that EU officials are currently in talks with Spanish policymakers regarding bailout plans.

According to a news report on Financial Times, euro zone finance ministers are ironing out a way for the Spanish government to implement budget reforms and take advantage of the ECB’s unlimited bond purchases program.

This report had market watchers speculating that Spain would upgrade its 100 billion EUR bailout for Bankia, which was granted in June, into a full-scale sovereign bailout sooner or later. However, Spain quickly dispelled these rumors for several possible reasons.

What’s Taking Spain So Long?

For one thing, the Spanish government is fully aware that a sovereign bailout won’t come easy. They would need to come up with a very detailed schedule of their austerity plans and reforms proposed by the EU and IMF. It doesn’t help that the government is currently facing violent protests on further pension cuts and wage reductions, forcing them to avoid those belt-tightening options.

Aside from that, political interests are getting in the way as local elections will take place towards the end of this month. Recall that Spain’s Prime Minister Mariano Rajoy delayed any budget-related announcements until after the elections in the city of Andalucia back in March.

Bear in mind that German elections are also coming up and that candidates wouldn’t want to hurt their chances of winning by declaring their support for austerity measures.

In fact, German Finance Minister Wolfgang Schauble was quoted earlier this week saying that Spain doesn’t really need a bailout at the moment. After all, the ECB just decided to loosen up monetary policy lately and this decision caused Spanish bond yields to retreat significantly.

Pressure mounts for the government to ask for a bailout

It looks like no one is buying Prime Minister Rajoy’s reassurance though. Despite his denial about Spain’s need for a bailout, most market participants believe that it’s only a matter of time until the government knocks on the Troika‘s door.

Heck, even local businessmen think that Rajoy should just ask for a bailout already. Those who have their headquarters in Spain complain that they are paying higher interest rates than their counterparts abroad, making their products less competitive.

It’s easy to see that the government is desperately cutting expenses and saving up as much money as it could in its latest set of austerity measures. However, analysts estimate that the country would still fall short of its deficit-cutting goals.

If you ask me, I don’t think you should hold your breath for a full-scale Spanish bailout to be announced anytime soon. Economy Minister Luis de Guindos is scheduled to release a new set of reforms and the 2013 budget this week. The government will probably wait a while to see how investors react to the new set of reforms before asking for help.

There are also those who say that Prime Minister Rajoy might put off the decision until the EU Summit on October 18 to 19.

How would a Spanish bailout affect the euro?

Perhaps the biggest event risk for the euro now is a credit downgrade from Moody’s. The ratings agency has been reviewing the Spain’s standing for the past few months and there have been rumors that the country may soon see its grade downgraded to junk status. Borrowing costs would probably rise if Moody’s goes ahead with a Spanish downgrade so I won’t be surprised to see the euro plunge under this scenario.

However, analysts say that if the government asks for a bailout before it receives a downgrade, the euro could actually trade higher as the move would get help eliminate uncertainty in the region.

Looking at how EUR/USD rallied last Friday when the talks of a potential Spanish bailout hit the headlines, it would seem that investors are more worried about the cost of the uncertainty surrounding Spain’s situation rather than the monetary sum of its bailout.

EUR/USD 15-minute Chart

Perhaps the most important issue here is not really whether Spain would ask for a bailout or not. What’s more urgent is that the government provides the market with some clarity on the economy’s situation.

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