Spain and Liquidity Injections Still on Europe Watch List

The problems faced by Spain and the long-term effects of the European Central Bank’s mass liquidity injections are still weighing down stock and currency markets around the world.

European Union Flag
Jonathan Kitchen | Image Bank | Getty Images
European Union Flag

On Wednesday, poor Spanish bond auction results sent markets down. European markets and the euro continued their downward trend on Thursday.

And analysts and economists warn that the long-term effects of the ECB’s liquidity injection, known as a long-term refinancing operation (LTRO) and one of the key drivers of this year’s rally, have yet to be felt.

“You need time for the LTRO to have an impact. If you look at credit numbers and borrowing costs in the periphery, it hasn’t had much impact yet,” Thanos Vamvakidis, head of European G10 foreign exchange strategy, BofA Merrill Lynch, told CNBC Thursday.

“We’re very concerned about the growth outlook for the periphery in the second half of the year.”

ECB President Mario Draghi said Wednesday that the central bank will not exit crisis mode yet, as he waits to see whether the second LTRO affects the real economy in Europe. There had been speculation that the ECB might lower interest rates even further from their current historic low of 1 percent.

“Even if he was to reduce rates today, it wouldn’t have much direct impact in the periphery,” Vamvakidis said.

Spain, which has taken over from Greece as the focus of investors’ concerns following the Greek debt deal last month, is far from out of the woods despite a budget which reinforced the government’s commitment to austerity.

The country faces a “severe recession” in 2012, followed by another contraction in 2013, and a further fall in house prices, according to analysts at UBS.

There are concerns that the entire real estate sector will suffer another devaluation, which could lead to further trouble in its banking sector, which is heavily exposed to domestic property.

“Their budget is credible but there are very important growth risks and if they try to meet this target it will deteriorate the economic outlook,” Vamvakidis said.

The euro has come under pressure this week as concerns mounted.

“Reserve diversification by central banks has supported the euro, but some are now selling it. It seems that the central banks can’t decide which is worse: quantitative easing in the U.S. or the euro zone crisis,” Vamvakidis said.

He predicted euro will stay at around 1.30 against the dollar but warns that there is some downside risk to this prediction.