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Spain May Spend Months in ‘No Man’s Land’ Over Bailout

Thursday, 18 Oct 2012 | 5:12 AM ET
Philippe Huguen

Spain's problems have been so widely discussed that the potential for the Mediterranean country to become the first major euro zone economy to make a bailout request, unthinkable earlier in the crisis, has gained widespread credence.

Yet it could spend months more deciding whether to ask for financial aid after an improvement in market conditions in recent weeks, economists and analysts have warned.

"Perhaps they feel like they don't need to agree a new deal. If you look at the markets right now, there's no huge bout of tension and usually when you get something from politicians, it's because the markets have forced it, " Jane Foley, senior currency strategist at Rabobank told CNBC Thursday. "The Spanish prime minister needs the pressure, we haven't got it, so we're in this no man's land."

Spain's debt problems aren't even on the official agenda at the summit of European Union leaders which gets underway on Thursday in Brussels. (Read More: Spain Watched at EU Summit .)

Analysts at Bank of America/Merrill Lynch argue that Spain's cash position and "relatively limited" market pressure will delay any immediate bailout request — although they still believe that it will ask for financial aid at some point, probably late this year or early 2013.

Stress in the banking sector remains a worry, with bad loans rising to 10.5 percent of total loans in August, according to data released by the central bank on Thursday.

On the other hand, Spain has covered around 90 percent of its funding needs for the year — and tax revenues for September should have risen after a hike in value added taxes (VAT). The economic indicators for the third quarter have so far been better than many hoped, with industrial production up by 1.3 percent on average for July and August, relative to the second quarter.

The government may also want to delay any request until after regional elections on Oct. 21 and Nov. 25. And Germany, fast becoming the paymaster of the euro zone , has its own electoral reasons to delay another high-profile, costly bailout for as long as possible, with regional and general elections due next year. (Read More: Why Spain's Reluctance Over Bailout Justified .)

On the other hand, worries that Spain will miss its budget deficit target of 6.3 percent for 2012 are increasing.

Thursday's auction of three bonds maturing in 2015, 2016, and 2022 resulted in more bonds being sold than expected, with the average yield down to 5.46 percent from 5.67 percent last month and an average this year of 5.91 percent.

Sovereign bond yields, once a relatively obscure market data point, have leapt to the foreground during the ongoing euro zone crisis. Spain's relatively healthy performance has been fueled by the European Central Bank's much-vaunted plans to keep peripheral yields low by buying up bonds if necessary, but these plans are not a straightforward positive.

"The drop in Spanish yields since late July has primarily reflected (ECB President Mario Draghi's) pledge to do "whatever is needed" to preserve the euro and to make bond purchases 'without limit.' Should such action not materialize — and in sizeable volumes — we think bond yields will rise sharply again, " Jonathan Loynes, chief European economist at Capital Economics, wrote in a research note.

This is also the dilemma facing traders, who have been discouraged from selling Spanish bonds after the ECB announcement.

"In a way, we're in a Catch-22 situation, " Rabobank's Foley said. "What is the point of selling Spanish bonds if you know that the very action will bring in the ECB and bring down the value of your assets?"

—By CNBC's Catherine Boyle; Follow Her on Twitter @cboylecnbc