June 18, 2010 / 2:19 PM / 9 years ago

German-Spanish whispering wars hit euro zone

* German, Spanish officials leaking against each other * German sources said Spain on brink of EU bailout

* Spanish countered with bank stress tests

By Paul Taylor

PARIS, June 18 (Reuters) - A whispering war between German and Spanish officials has exacerbated the euro zone’s debt crisis this month, keeping financial markets on edge and exposing deep frustrations in Berlin and Madrid.

European diplomats say the background to the leaks and counter-leaks lies in pressure from Germany — Europe’s economic powerhouse and main paymaster — for Spain to take tougher austerity measures to cut its huge budget deficit.

The Germans seem to have fired the first shot, telling journalists in Berlin on condition of anonymity on June 7 — the day the German coalition agreed on its own austerity package — that Spain was on the brink of seeking a European Union bailout.

Two German officials told Reuters that the Spanish government would make an announcement concerning the European Financial Stability Facility that day, when European finance ministers were meeting in Luxembourg to finalise details of the 440 billion euro backstop arrangement for euro zone states.

The sources said they could not rule out that Madrid would apply to use the mechanism, or draw on a 60 billion euro ($74.29 billion) EU stabilisation fund that was already available, although it might try to raise money in the market first.

The hints drew flat denials in Madrid, Brussels and Luxembourg, where participants at the finance ministers’ meeting said Spain had made no such request.

After extensive checks, Reuters decided there were no facts to report. But the rumours were already affecting the markets.

The story eventually surfaced in a different form last Friday when the Financial Times Deutschland newspaper reported without citing sources that the European Union was preparing to activate an aid package for Spain in case Madrid requested it.

The Frankfurter Allgemeine Zeitung on Monday quoted a German government source as saying EU states were preparing to help Spain with credit and would discuss the matter this week.

FURIOUS

Diplomats said Spanish Prime Minister Jose Luis Rodriguez Zapatero was furious and demanded to know in Berlin and Brussels where the reports were coming from.

Asked about the German media reports, Chancellor Angela Merkel told reporters that day: “If there should be problems — and we shouldn’t talk them up — the mechanism can be activated at any time. Spain and any other country knows that they can make use of this mechanism if necessary.”

The reports sent the euro down against the dollar and pushed up Spanish borrowing costs on credit markets, traders said. By mid-week, the risk premium investors demand to hold Spanish debt instead of benchmark German bonds had risen to a euro lifetime high of almost 240 basis points.

Foreign banks had frozen lending to some Spanish banks amid mounting concerns about Madrid’s fiscal woes.

The counter-attack began on Tuesday, when El Pais newspaper quoted Spanish government officials as saying Madrid wanted to publish the results of stress tests being conducted on its banks to reassure markets — a move hitherto opposed by Germany.

“If the results of the tests were known there would be more than one surprise,” one of the sources was quoted as saying, noting that Spanish banks had performed well.

The next day, the Bank of Spain said it would soon issue unilaterally the results of tests of capital adequacy and risk resilience being conducted on Spanish banks.

That forced the hand of EU leaders, meeting in Brussels on Thursday, who decided at Zapatero’s initiative, with the support of the European Commission, to make bank-by-bank results public on the top 25 banks by the end of July.

Asked about talk of an imminent bailout request after that summit, the Spanish leader said: “I understand that this rumour is around, but what I would say is that you should be patient and that you should listen to what the Spanish government says and ignore the rumours.”

Zapatero’s minority Socialist government announced deficit cutting measures in mid-May worth 15 billion euros over 18 months, soon after European finance ministers agreed on a $1 trillion financial safety net for the euro zone.

The savings were worth 0.5 percent of gross domestic product this year and 1.0 percent in 2011. But EU diplomats said Berlin was still pressing for sharper cuts.

A draft EU document presented to ministers on May 9 and seen by Reuters had called for cuts of 1.5 percent this year and at least 1.0 percent next year but Madrid negotiated that down.

EU officials, reluctant to speak on the record about the dispute, said the European Commission was flabbergasted by the leaks, which were damaging the euro zone.

“We simply cannot understand how this can be in Germany’s interest, or anyone’s interest in the euro area,” an official involved in crisis management said.

additional reporting by Matthias Sobolewski in Berlin, Julien Toyer in Brussels, Paul Day and Nigel Davies in Madrid; editing by Elizabeth Fullerton

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