Euro falls to three-week low against US dollar as IMF warns of ‘severe’ challenges facing Spain
Guardian UK | April 5, 2012
Worries about Spain‘s perilous economic outlook and the threat it poses to its fragile eurozone neighbours intensified on Thursday night as investors dumped the euro and riskier government bonds ahead of the long holiday weekend.
The International Monetary Fund fanned those fears by asserting Spain is facing “severe” challenges. It insisted last week’s strict budget must be put into practice, with Spain meeting European Union demands for it to cut its deficit.
“We will point to the need to ensure compliance with the new target, not just at the central level also at the regional government level,” said IMF spokesman Gerry Rice. “Clearly the challenges Spain is facing are severe. Market sentiment remains volatile.”
The euro fell to a three-week low against the dollar on concerns about repercussions for the wider currency zone from problems in Spain, whose economy is twice the size of that of Greece, Ireland and Portugal combined. Borrowing costs on Spanish and Italian bonds continued to rise as investors moved into assets seen as less risky, including German and US government bonds. In thin pre-holiday trading, stock markets in Europe closed little changed on the day.
The IMF’s remarks concluded a week of gloomy news from Spain in which the government conceded its debts will balloon this year to their highest level for two decades. That provided a tough backdrop to the country’s latest bond auction and the sale came in at the low end of the government’s target range. To placate fears that it might eventually become the fourth eurozone country to require an international bailout, the government had to offer investors an interest rate of 5.338% on debt maturing in 2020 – higher than the 5.2% forecast and the 5.156% offered when the debt was last sold in September 2011.
Economists have highlighted the widespread challenges Spain faces from the highest unemployment rate in Europe, with youth unemployment at 50%, rising borrowing costs, stretched local authorities and a troubled banking system.
“We’re increasingly worried about Spain on the back of the sovereign’s rising yields and the potential for contagion,” said analysts at Société Générale. “Spanish corporates are feeling the heat with clear daylight between them and their Italian counterparts in recent sessions.”
The European Central Bank has sought to keep borrowing costs in eurozone states in check by injecting funds into financial markets in the hope banks will use them to buy bonds. But bond market experts say the effects of the so-called LTRO scheme are wearing off, leaving Spain particularly vulnerable.
“The impact of the LTRO has faded, meaning Spanish banks maybe are not as willing or able to take down large chunks of Spanish debt at every auction,” said Chris Iggo at AXA Investment Managers.
“Unfortunately, the European peripheral debt problem is not going away. The increasing domestication of European debt markets is also a concern as it further concretes the relationship between banks and the sovereign.”
But IHS Global Insight economist Raj Badiani cautioned that thanks to ECB support Spain was “not in any immediate danger”. The problems are further out, he said. “The risks are expected to intensify in 2013, with Spain battered by a crippling combination of a lingering economic downturn, challenging financing requirements, a labour market close to meltdown, and a banking sector struggling to contain ever-increasing troubled real-estate assets.”
News from the eurozone’s largest member, Germany, also unsettled financial markets on Thursday. Recession worries were fanned as government data revealed a sharper than expected fall in German industrial output in February. The 1.3% drop reversed January’s rise as cold weather hit output in the construction sector in particular.
After weak exports pushed Europe’s biggest economy into negative territory at the end of last year fears remain that it will have again failed to notch up any growth in the first quarter of 2012, thereby slipping into a technical recession.
The outlook for industry, and manufacturers in particular, remains tough with business surveys pointing to lower orders from the embattled eurozone, economists say.
“The recovery in German manufacturing output is unlikely to regain significant traction for several months to come,” said Chris Scicluna and Emily Nicol at Daiwa Capital Markets.
This article was written by Katie Allen.