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Spain has a new government but political instability is not over

Key Points
  • The instability of this socialist executive is leading many to predict a snap election before the current mandate ends in July 2020.
  • One of the main stumbling blocks is the lack of parliamentary majority. Sanchez's party has only 84 of 350 seats.
  • Spain grew at a rate of 3.1 percent last year, according to data from the European Commission. And that's expected to narrow to 2.9 percent this year.
Spain's Socialist Party (PSOE) leader Pedro Sanchez attends an investiture debate at parliament in Madrid, Spain, March 2, 2016.
Andrea Comas | Reuters

Spain has a new leader but many analysts believe he will not stay in power until the end of his mandate, potentially raising further uncertainty for market participants.

Pedro Sanchez, leader of the Socialist Party (PSOE) became prime minister last week. This after he received support from anti-austerity and nationalist parties to oust the former leader, Mariano Rajoy, over a corruption scandal involving members of the Rajoy's Partido Popular (PP) party. However, the instability of this socialist executive is leading many to predict a snap election before the current mandate ends in July 2020.

"We see only limited chances for the new government to stay in power until 2020," Johannes Mayr, who conducts investment research at Bayern LB in Germany told CNBC Tuesday via email. He pointed to snap election at some point in 2019.

The Canadian credit rating agency DBRS also said Friday that it "expects PSOE to lead a transitional government, with limited ability to steer policies in a different direction in the short term, and to eventually call for early general elections in the coming months as it faces difficultly in legislating."

One of the main stumbling blocks is the lack of parliamentary majority. Sanchez's party has only 84 of 350 seats. The vote of no-confidence on Rajoy last week received the support of 180 lawmakers, thanks to several fringe parties. On Monday, the now opposition party Partido Popular threatened to use its majority in the Senate to block a vote on the country's budget later this year.

VIDEO3:2503:25
Spain's new prime minister Pedro Sanchez can be a unifying figure: Lawmaker

Maartje Wijffelaars, a senior economist at Rabobank, said that "either (Sanchez) comes to acknowledge himself that new elections are the only way to go at some point, or Parliament makes him acknowledge that" due to his lack of a solid majority.

However, according to a top aide in the new government, a new vote would not erase the political divide in the Parliament. Jose Luis Abalos, often described as Sanchez's right-hand man, told COPE radio according to Reuters, that "it's clearly unusual to govern with 84 lawmakers but the political situation remains very fragmented and everything suggests a new election wouldn't fix that."

But analysts argue that an unclear policy agenda, with a potential rollback of several labor and pension reforms, is worrisome. The new premier called Monday for more equality for Spanish citizens in what was another sign that Sanchez could try to dial back some austerity measures.

According to ratings agency DBRS, the economic momentum in Spain has so far survived the political headlines, but it added that "significant economic and fiscal challenges call for additional fiscal measures."

Spain grew at a rate of 3.1 percent last year, according to data from the European Commission. And that's expected to narrow to 2.9 percent this year. However, its public deficit remained above 3 percent of gross domestic product (GDP) last year and its public debt stood at 98.3 percent of GDP.

Opinion polls released in May showed the liberal party Ciudadanos getting the most support, with PP and PSOE fighting over the second place. If this support materializes in a general election there could be a positive move in Spanish markets.

"Due to Spain's regional proportional election system it is difficult to translate popular vote polling into seat distribution, but if indeed Ciudadanos would be the largest (party) this could be good for Spain," Wijffelaars said. "In the previous elections they had a good policy agenda, including reforms that should benefit Spain's growth potential," she added.

Spanish stocks have fallen sharply in the last two weeks, due to the political changes in the country but also elsewhere in Europe. However, the main Spanish index has started to recover some of those losses in the last 48 hours.