Spain Calls Europe’s Bluff as Region’s Debt Crisis Eases

Europe's four-year old debt crisis seems to be in remission. Dutch voters backed pro-euro parties in Wednesday's poll, the German Constitutional Court gave the go-ahead for the region's permanent bailout fund and the European Central Bank's (ECB) latest bond program seems to be working, even before it's begun.

Mariano Rajoy, Prime Minister of Spain.
Radolpho Saenz | AFP | Getty Images
Mariano Rajoy, Prime Minister of Spain.

Yields on Spanish and Italian bonds have fallen, the euro is at its strongest in four months against the dollar and European stocks are trading at their highest in almost a month.

The turnaround has been so dramatic that it's allowed Spain, one of the most badly affected countries, to suggest that it may not need aid after all.

"I don't know if Spain needs to ask for it," Spain's Prime Minister Mariano Rajoy told parliament on Wednesday, referring to external aid.

But according to Nicholas Spiro, managing director of Spiro Sovereign Strategy, even though the ECB bond plan is "working wonders," it won't prevent Spain from eventually seeking a bailout. (Read More:Italy Has No Plans to Tap ECB Program: Monti)

“Many in the market are feeling that there is a ‘Draghi put’ and the mastery of this plan is that it could work without spending a single cent, which is preposterous," he said on Thursday. "It is seeping into the conciousness of many Spanish politician — that they could actually ride this out."

But that's easier said than done because Spain faces a multitude of problems — each interlinked with the other — including a banking crisis, a housing bust, heavily indebted regions, and a sovereign funding crisis.

On Thursday Spain's Treasury said it would raise 3 billion euros of debt in a private placement with the banks. The money would go towards an 18 billion euro rescue fund for the country's struggling regional governments.

As all this plays out, Spiro says there could be two immediate triggers that could drive Spanish yields back up and force Spain's government to seek European Union help.

The first could be another downgrade of Spain's credit rating by Moody's. The agency downgraded Spanish sovereign debt in June to one notch above junk and warned that it could slash its rating again within three months.

Spain also faces 30 billion euros of debt redemptions at the end of October, according to Spiro.

On Wednesday, Moody's Chief Credit Officer for Europe, Middle East and Africa said the ECB bond program was an important announcement, but it wouldn't solve the crisis.

"It can buy time for the governments to take the necessary actions," Alastair Wilson warned.

His comments were echoed by analysts at Goldman Sachs who said: "A swift and smooth move by Spain to request external support is needed to validate the recent improvement in market sentiment towards Spain."

In a note titled: “Tensions With Spain Set To Increase, Sooner or Later,” Goldman said Spain may be delaying asking for help because of domestic political constraints or because it wants to wait till the publication of bank stress tests at the end of September. (Read More: Europe to Pay 'Terrible Price': Jim Rogers)

But Goldman analysts warned that Spain's delay in asking for help could actually backfire, with tougher conditions imposed by the German government on a final bailout, which would worsen the crisis.

"The more the Spanish administration indulges domestic political interests and is perceived to be taking undue advantage of external support, the more explicit conditionality is likely to be demanded," the report said.

"This is disappointing partly because it is avoidable if Spain were to accept the external support on the terms currently available," Goldman Sachs said.

“Spain will have the opportunity in the coming weeks and months to demonstrate that it wishes to avoid these incipient risks. But we continue to believe that some of the incentives created by Mr Draghi's preparedness to act could prove difficult to resist."

By CNBC’s Deepanshu Bagchee; Follow Him on Twitter @DeepBagchee