Mariano Rajoy thinks it is better to volunteer for pain than be forced into it. The Spanish prime minister hopes that his reform plans will be deemed credible enough by the European Central Bank to allow it to help Madrid with its still-untested new-style bond-buying programme. He then could pretend that he hasn’t been forced into doing anything he didn’t want to do.
Ever since Mario Draghi, the ECB president, announced his bond-buying intentions in August, Rajoy has denied that Spain would need this new form of bailout. Initial market reaction may have encouraged him in that direction. Yields on 10-year bonds fell from their July high of 7.6 per cent to less than 5.8 per cent on Friday.
But the main reason for the steep decline in yields has been investors’ expectations that Spain would ask the ECB for support. If it doesn’t, markets might cool on the country’s prospects. That would largely be irrational, since Rajoy’s tendency to waver does not change the government’s overall commitment to reform. In the latest development, according to Reuters, the Spanish premier seems to be ready to renege on his oft-repeated pledge not to touch the generous pension system.
As Spain gears up to accept help, investors will ponder another question: what interest rate on sovereign debt will the ECB and Germany consider sustainable? Berlin has been hinting that Spain could make it without a bailout at current yield levels, which are high enough to guarantee that some market discipline applies. This shows a refreshing belief in investors’ rationality.
The ECB, on the other hand, is more ambiguous. It must have an idea of the desired level, and is not telling. Something around five per cent is plausible, but the central bank’s judgement will be influenced by other factors, notably how Madrid handles its separate bank bailout, and the impact of the Euro zone recession on the country’s finances.
Bailout or not, markets, Germany and the ECB will keep pressuring Spain. So, Rajoy may want to spend what’s left of his political capital on more serious matters than a rearguard defence of Spanish pride.
