Following a disappointing bond auction in Madrid on Thursday, the firewall that markets thought existed between Greece, Portugal and Ireland and the much bigger and systemic economies of Spain and Italy is in danger of being shown to be an illusion, according to Mike Riddell, a fund manager at M&G in London.
"The last thing that financial markets needed this morning was a wobbly Spanish auction, but that’s exactly what they got. Spain’s borrowing costs have soared, with 10 year Spanish government bond yields jumping a massive 20bps at one point," said Riddell in a research note Thursday.
"One bank reported zero buying interest from their clients, and with the auction not well placed, dealers have been selling into the market," Riddell added.
"It’s difficult to focus on the long term when there’s such a big short term risk of a horrible air shot as the authorities collectively try to kick the proverbial can," he said.
With Spain's long-term borrowing costs exceeding its nominal growth rates Riddell sees trouble ahead.
"Its potential long term real growth rate may now be as little as one percent, and with the ECB desperate to demonstrate its inflation fighting credentials, Spanish nominal growth potential could quite feasibly be below three percent," he said.
"For Spain’s debt levels to stabilise, either Spain’s borrowing costs will need to halve or it will have to run a large sustained budget surplus to make up this gap," Riddell said.
"Given that it’s exceptionally unlikely that Spain is in any position to run a sustained budget surplus, Spain’s public debt/GDP ratio will steadily deteriorate," he added.