The Spanish recession is deepening and there is little hope for a turnaround anytime soon. This is putting pressure on the Spanish government to ease up on austerity measures designed to cut the budget deficit in order to reduce the cost of borrowing.
While the cost of short term bonds has fallen, the meat and potatoes of the Spanish debt problem arises in costs associated with 5 and 10 year bonds that are still very high. But does Prime Minister Rajoy have the political capital to keep Spain on track to reach their deficit targets?
They may need some help in the form of more funding from the EU.
"We fear that things are likely to get worse before they get better," said Martin van Vliet, an economist at ING Bank in Amsterdam, who expects Spain will seek additional financial aid as early as next month. "With much more fiscal austerity in the pipeline and unemployment at astronomic highs, the risks are clearly tilted toward a more protracted recession."
Separate data today from the ECB showed that private-sector deposits at Spanish banks fell by a record in July, dropping 74.2 billion euros ($93 billion), or 4.7 percent, to 1.51 trillion euros. That's the biggest decline since at least 1997, when the ECB's data series started.
The Spanish GDP report showed that consumer spending dropped 1 percent in the second quarter, investment dropped 3 percent and government spending declined 0.7 percent. Exports of goods and services rose 1.6 percent. The economy grew 0.4 percent last year, less than the 0.7 percent initially stated, the statistics agency said. The 2010 contraction was 0.3 percent, revised from 0.1 percent.
Deputy Economy Minister Fernando Jimenez Latorre said it is too early to tell whether the revision will impact the nation's deficit goals. He also said the economy is in its worst phase.
"We are in the moment of steepest fall and it will surely continue in the second half of this year," he said. "We will see a correction starting in the first quarters of next year."
The yield on Spain's 10-year benchmark bond rose 2 basis points to 6.41 percent as of 11:55 a.m. in Madrid. The yield has fallen since reaching a record of 7.75 percent on July 25 after ECB President Mario Draghi said the central bank may intervene to curb governments' borrowing costs and win them time to implement fiscal changes.
Because Spain is making a supreme effort to get its deficit under control, they are likely to get additional funds if they ask for them -- especially since they would request only a fraction of what it would cost to bail out the entire economy. Unlike Greece, Spain has met most of its deficit targets but it appears that many investors are pulling out in advance of some potential bad news next month about the stability of the banking system. The 100 billion euro bank bailout granted by the ECB two months ago may not be enough to staunch the red ink.
Spain is limping along while Greece may not survive unless it receives considerations from the EU. The shock of a Greek exit may change the situation dramatically in Spain which is one reason why the EU may bend over backward to keep Greece in the euro zone.