MADRID (Reuters) - A resounding election victory by Spain’s center-right People’s Party failed to calm nervous debt markets on Monday as concern over the deepening euro zone crisis and a lack of concrete proposals meant risk premiums continued to climb.
The difference between Spanish and German bond yields rose to 472 basis points in early trade, up by around 28 bps from settlement on Friday and yields on its 10-year paper rose in line with troubled Italy.
Spain is the fifth euro zone member to have kicked out its government over its handling of the crisis, after Italy, Greece, Portugal and Ireland, though individual efforts by new governments have done little buoy market sentiment.
Italy’s new technocrat government is working on austerity measures to balance the budget by 2013, while Ireland last week proposed a 2-percentage-point hike in value-added tax and is reportedly looking at cutting welfare to tame spending.
“It’s a little bit late in the day to be looking to austerity and certainly nothing we have seen from the Irish government has turned around sentiment significantly in the interim,” Harvinder Sian, an interest rate strategist at RBS, said.
The widening spread on Monday was largely due to the absence of the European Central Bank in the market, he said, which has been buying Spanish and Italian bonds since August to offset wider selling on concerns they would need aid.
“The suspicion is, without the ECB being involved these spreads will be materially wider, and ultimately, if the ECB does become a little bit less aggressive in its buying action, the EFSF (EU rescue fund) beckons for both,” Sian said.
Austerity measures and economic reforms by the Spanish Socialists, which ultimately cost them the election, have kept markets from pushing Spain to the limit of sustainable financing costs but deeper cuts are needed.
For the new government to meet the public deficit target of 4.4 percent of gross domestic product by end-2012, it will have to slice around 30 billion euros ($40.6 billion) from the budget, punishing for an economy expected to sink in to recession by early next year.
While the sovereign debt market remained unmoved by the PP win, Spain’s blue-chip IBEX index moved lower on Monday as traders took profits from pre-election buying on Friday.
“The market reaction to the absolute majority was already in the price and that’s why, in part, it is falling. If the PP hadn’t won a majority, the market would have fallen much more,” the managing director of Bilbao-based broker Mercagentes, Alberto Zumarraga, said.
Spanish banks continued to trail, in line with their European counterparts, as the new government majority did little to allay short term funding concerns in a paralyzed market.
With one in five Spaniards out of work, the banks choking off new loans to meet tough capital requirements and the construction sector still in the doldrums, the PP will have to work hard to convince investors it can turn the economy around.
New leader Mariano Rajoy, to be sworn in by mid-December, will hold a clear mandate with the largest Parliamentary majority for any party in three decades.
But he has still to outline any concrete proposals and has pleaded with markets for time to tackle the crisis, time he can barely afford as 10-year bond yields hover near the key 7 percent level.
The first big test for market sentiment since the election will come on Tuesday, when the government issues around 3 billion euros in short-term Treasury bills.
However, the result is unlikely to offer any relief with both the 3- and 6-month bills seeing yields on the secondary market on Monday at levels not seen since before the introduction of the euro.
“They still haven’t done anything so it makes sense there’s no support for the market. It’s good they’ve won a majority, but the global economy remains in a bad way, and this won’t change one day to another,” a Madrid-based bond trader said.
“The problem remains. There are no clients. There is no interest. Maybe the ECB is buying bonds, but it’s the only one that is.”
Additional reporting by Jesus Aguado; Editing by Angus MacSwan