EU’S NEW CRISIS MODEL GIVES SPAIN MORE TIME FOR CUTS

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Contributor / 2012-07-13 19:25:34

Last week the Bank of England and the ECB both announced further monetary policy stimulus in reaction to a deteriorating economic picture in Europe. Last night the market was focused on how likely the US Federal Reserve is to follow suit, and announce something more aggressive than extending operation twist. In their latest minutes the Fed was split between those who thought further stimulus was already warranted and those in the wait and see camp.

A ‘few’ members thought further policy stimulus would be necessary to promote growth and employment but ‘several’ others noted further action could be needed if the economic recovery loses momentum, or if inflation seemed likely to run persistently below the Fed’s long-run target.

Onto Europe where European leaders are testing the latest version of their debt crisis strategy in Spain, granting Prime Minister Mariano Rajoy more time to reduce the budget deficit in exchange for deeper spending cuts. Rajoy yesterday announced 65 billion Euros of austerity measures in a renewed effort to meet European Union budget targets after he was granted a one-year extension on the deadline to meet EU limits. Europe’s concession to recession-wracked Spain has raised expectations in Ireland and Portugal that they can win more time to rein in their budget deficits after Germany’s hardball tactics in Greece spurred a rebellion against bailout politics there. Rajoy’s budget package came as Spain finalizes the conditions of a 100 billion-euro bank rescue bank that will allow International Monetary Fund officials to intervene in the process of restructuring the banking system and tightens scrutiny over spending plans.

European leaders also held out the prospect of buying Spanish debt to trim yields as long as Rajoy complies with their conditions, which include transferring powers from the Economy Ministry to the Bank of Spain and bolstering the central bank’s independence. Rajoy is also seeking additional cuts from the 17 regional governments, which control health and education. Even as Spain’s own access to capital markets is narrowing, the central government is planning to help states fund themselves on markets. Budget Minister Cristobal Montoro meets regional finance chiefs today at 4 p.m. in Madrid to discuss the plan. Pay cuts and holiday restrictions for public workers will save 6.3 billion Euros a year, Deputy Budget Minister Antonio Beteta said yesterday. With the extra year, Spain has until 2014 to bring its deficit within the EU’s 3 percent limit. European finance ministers agreed to loosen the 2012 deficit goal to 6.3 percent of GDP from 5.3 percent. Still, ministers urged Spain to step up budget cuts.

The net effect across the currencies has been another round of strength for the US Dollar. There is a general sense of risk aversion in early European trading after Australian unemployment rose slightly and South Korea unexpectedly dropped its key interest rate by 25 basis points, and the commodity currencies and Sterling are all trading lower than yesterday evening.
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