Spanish Stocks Sink as Full Bailout Fears Grow

Spanish stocks fell sharply on Monday amid fears that a number of regional governments will ask Madrid for financial support. The falls come after Spain's IBEX index fell by nearly 6 percent on Friday when Valencia, a region on Spain’s southern coast, said it would seek financial support from the central government.

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Figures released on Monday underlined the concerns surrounding Spain. The country saw economic growth contract by 1 percent year-on-year in the second quarter. On a quarterly basis the economy contracted 0.4 percent.

Spain's economy minister Luis De Guindos ruled out the possibility of a full-scale bailout on Monday, but markets remained nervous.

Asked about this possibility on the sidelines of a congress hearing about the European aid to ailing Spanish lenders, De Guindos told Reuters: "Absolutely not."

Spanish 10-year borrowing costs rose sharply to trade around 7.5 percent having traded below the key 7 percent mark just days ago.

Over the weekend media reports indicated Murcia, a small region to the south of Madrid would be the second of Spain’s 17 highly indebted regional governments to seek aid. Speaking in a local newspaper, the head of Murcia’s local government Ramon Luis Valcarcel said he hoped to tap government funds.

"Nobody should think this money is a gift, the conditions are going to be very tough," the paper cited Valcarcel as saying. "To give you an idea, between 200 to 300 million euros would be asked for. But I don't know yet."

Spain’s regional governments must refinance 36 billion euros worth of debt this year, having been locked out of the international debt markets by the euro zone debt crisis. Spain’s central government announced earlier this month that it had set up an 18 billion euro fund to help its ailing regional governments.

Spain’s finance minister Luis de Guindos will reportedly fly to Berlin on Tuesday for a meeting with German finance minister Wolfgang Schaeuble. In an interview in Monday’s edition of Germany's Bild newspaper Schaeuble said he expected Spain’s economy would bounce back from painful adjustments, arguing that the euro zone’s fourth largest economy is powerful and would recover from its real estate-induced economic downturn.

The sell-off of the last few days has been driven by a number of factors, according to economists at Capital Economics. One of those is the German finance minister's insistence that Spain’s government be liable for funds handed to Spain’s banks by the European Financial Stability Facility, Europe's rescue fund.

Germany’s attitude will do nothing to break the “vicious circle between banks and sovereigns” that EU policymakers asserted was “imperative to break” in the statement that followed their 29th June EU Summit, John Higgins, senior market economist at Capital Economics said in a research note. "This is all the more concerning because the link between banks and sovereigns in Spain is getting stronger as foreigners head for the hills,” said.

Simon Derrick at Bank of New York Mellon warned thar the aggressive move in Spanish bond yieldscould indicate that Madrid will follow Ireland, Portugal and Greece and request a bailout.

“Little surprise then that the IBEX 35 fell 5.8 percent on Friday alone, to leave it standing 35 percent down year-on-year, or that El Pais this morning is warning of a 'Black Monday' for Spanish markets,” wrote Derrick on Monday.

“While it might be perfectly possible for Spain to limp along until October, it also seems reasonable to suppose that other members of the euro area will be unwilling to allow the current situation to drag on until then for fear of contagion,” said Derrick, who believes the key risk is Italy.

“Undoubtedly Italy will be at the forefront of the nations looking for Spain to make an early request for broader support given that Italian 10-year yields spiked above 6 percent on Friday and that the FTSE MIB fell 4.38 percent. With Silvio Berlusconi indicating that he is looking to make a swift return to politics, the government in Rome ((or, indeed, authorities elsewhere in Europe) will not wish to give him any more ammunition than they absolutely have to," he said.