Fairly appropriately, the European Central Bank holds its monthly policy setting meeting in Barcelona this week. Not that it can do much to ease the pain of Catalan football supporters post Barca's Champions League exit and the loss of their coach but at least they'll get a firsthand account of what's going on at the frontline of Europe's economic battleground.
On the face of it, market reaction to S&P's two-notch downgrade of Spanish debt and news that nearly one in four of the working population is now unemployed was very muted. Then again to anyone who has looked at the numbers it was pretty clear which way the trend was going and, as S&P suggests, will continue to do so.
The Spanish government commented on Friday that it may have to put more money into the banking sector. They would aim to do so without resorting to euro zone funds but plenty wonder if that's feasible. If Spain did take aid from the European Union, then bondholders face a risk of subordination, something definitely not in the price. S&P's Moritz Kraemer told me it would depend on where and when the money was taken. If from the European Financial Stability Facility , in place until July – there would be no subordination in the event of a default but if they wait until when the ESM has replaced it at the end of that month, it's a different story.
Regardless of that time bomb, most if not all fixed-income guests I interview expect yields on Spanish debt to have a sustained move higher, well above 6 percent. It would then be reasonable to expect the European Central Bank to reopen its Securites Markets Program – under which it buys sovereign bonds in the secondary markets - and restart the practice of buying peripheral debt.
But the threshold for doing so might be quite a bit higher than some think. As Capital Economics point out: "with governments' commitment to austerity seeming to slip lately, council members are likely to have become more rather than less reluctant to step up their bond purchases." The inference is that "while the bank may strike a more downbeat tone it will continue to stress only governments can solve the crisis." Whether they can is another question.
In the meantime the ECB might help the periphery by holding rates as low as it can, even if it risks something that might resemble a reflationary boom for the core. Sarasin point out that according to the Taylor rule, Germany would require the ECB to hike rates to close to 6 percent, while the economic conditions in the periphery point to a need for negative interest rates.
Sarasin's Guy Monson says holding rates falsely low for prolonged periods always risks asset and investment bubbles, a fate that likely awaits Germany and possibly Switzerland, via the Swiss franc's "ceiling" against the euro. As a result investors in real estate, exporters, insurance and perhaps even one day bank assets in those countries will ultimately benefit.