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European markets are getting slammed to start the week, and everyone is talking about Spain.Across Wall Street, there seems to be agreement on one thing:
“The next 5 days will be crucial for [Spain] and Europe overall.” – Dave Lutz, Stifel Nicolaus
“The focus this week is on the triple announcement from Spain (due 27-28 September) on the budget, reform, and banks.” – Michala Marcussen, Société Générale
“Today marks the beginning of a big week for Spain, as the government presents its 2013 draft budget plan, a package of new structural reforms and the results of its banking stress tests on Friday September 28.” – Guillaume Menuet, Citi
Investors will be hit with Spain headlines from all three fronts mentioned above on Friday – here’s SocGen economist Michala Marcussen’s take on the big events this week:
1. Budget 2013: Substantial efforts will be required to meet the 4.5% of GDP budget deficit target, down from 6.3% in 2012. A pension freeze (cf. below) is one possibility, but markets will also be keeping close watch on tensions with the autonomous regions, and notably with Catalonia. A meeting last Thursday between Catalan leader Mr Mas and PM Rajoy yielded no tangible outcome and the risk remains for an early election in Catalonia.
2. Structural reform: Press reports suggest that pension reform could be at the heart of the package to convince both markets and its European partners of Spain’s resolve. The reform could see the increase of the retirement age from 65 to 67 fast tracked and a freeze pension indexation. The later move could save as much as €5-6bn in 2012 (or around 0.5% of GDP). Other areas for reform flagged by the EU Commission include taxation, labour markets, SME funding and additional service sector deregulation.
3. Bank stress tests: Consensus for bank recapitalisation needs hover around the €60bn mark – a number also flagged by Finance and Economics Minister de Guindos. Too low a number will raise concerns that there are more hidden losses to come – all the more given the very frail economic backdrop.
MARKET ISSUES: Markets want Spain to seek assistance and put the ECB’s OMT to the test. The triple announcement this week should set the stage to meet the conditionality for financial assistance, but Spain may still opt to wait before making an official request. Several dates will frame market views on when Spain might request a bail-out: the next Eurogroup meeting on 8 October (ahead of the Council on 18-19 October), major redemptions in October (€31bn in total), 21 October regional elections in Galicia and the Basque region and the 12 November Eurogroup meeting. Pro-longed foot dragging by the Spanish government is likely to yield a negative market response.
And on the bailout front, SocGen rates strategist Ciarán O’Hagan expects to see a deal this week:
It still looks like Spain and Greece will be given out-of- jail cards. Friday saw Bonos and GGBs rallying with Bunds under pressure. The press is generally endorsing our views (more in SG FI Weekly) today that Bonos are likely to qualify for official bond buying on the back of reforms announced in the coming days. That was the talk of the town at Eurogroup last Saturday week.
Thus, if all goes well for Spain this week, it could represent a major step forward in the euro crisis as the ECB’s game-changing bond-buying plan is finally put to the test.
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