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The next big worry for the eurozone

Spain
After a warning from the credit rating agency Moody’s that Spain’s credit rating might be downgraded, the euro slid hard against the dollar yesterday (16th December 2010). Spain is the big worry for the eurozone. Ireland and Greece were nasty blips, but they could be coped with.

A bail-out for Spain would be much harder to swallow. To sort that one out, the leaders of the eurozone would have to come to a much more long-term solution to the region’s debt problems.

Spain has three main batches of debt to worry about:
• the central government has to raise and refinance a very substantial sum in 2011, some €170bn
• loans from the regions, €30bn worth also needs to be rolled over next year
• and another €90bn of borrowing by the banks.

Foreign investors aren’t keen on eurozone debt at the moment and a further problem for Spain’s government is that it has historically relied on overseas buyers “for about 50% of all the money it raises.”

That’s all bad enough. But it could get worse. Moody’s is worried that banks might have to raise more capital, which would probably have to come from the Spanish government. And there’s also the danger that austerity measures aren’t being imposed strictly enough. In all, Spain could end up needing to raise a total of €365bn, or 34% of its GDP next year.

Portugal
Portugal is trying to borrow more money from the markets via a bond auction this week. It will be selling ten-year government bonds. It’s the first of the most indebted eurozone countries to try to sell its debt this year.

The problem isn’t so much that the auction might fail. The real problem is the rate at which Portugal has to borrow.

As Bloomberg notes, the yield on Portugal’s existing ten-year bonds has been driven up over 7% on ten of the last 62 days (in other words, the price of ten-year bonds has fallen). A year ago, it cost Portugal just 4% to borrow money for ten years.

Why is that significant? Because 7% seems to be the magic number at which countries are destined for a bail-out. “Greece needed a rescue within 17 days of its ten-year yield breaching 7%… while Ireland lasted less than a month after it cracked that level in October.”

Portugal’s real problem is that its economy is stagnant and its private sector is over-borrowed. As with so many other global economies, years of overly-lenient interest rates allowed consumers to party at a time when their economy should really have been reformed to improve productivity growth.

The problem is that if Portugal is bailed out, it reduces the amount of money left over in Europe’s big bail-out fund for other troubled countries. And there are at least two of those lining up. There’s Belgium, which has a large national debt and no government to tackle it. And then there’s Spain, which is trying to raise money from the market later this week too. The yield on ten-year Spanish government bonds is around 5.5%.

The good news for the eurozone is that both Japan and China have weighed in to say that they will support Europe. Japan has said it will buy bonds issued by the bail-out funds, while China has said it will keep buying Spanish debt.

What does all this mean for the euro?

All that can be said with any certainty is that the euro faces very uncertain times. And while its future is in doubt, there will be lots of volatility, as investors swing from optimism to pessimism with every new initiative announced by Europe’s leaders.

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