Spanish economy in crisis after credit downgrade

Spain’s sickly economy faces a “huge crisis ”, as unemployment hit its highest level in almost two decades and S&P’s weighed in with a two-notch downgrade of the govt’s debt.

Unemployment shot up to 24 per cent in the first quarter, one of the worst jobless figures in the developed world. Retail sales slumped for the twenty-first consecutive month as a recession cuts into consumer spending.

“The figures are terrible for everyone and terrible for the government... Spain is in a crisis of huge proportions,” Foreign Minister Jose Manuel Garcia-Margallo said in a radio interview.

Standard and Poor’s cited risks of an increase in bad loans at Spanish banks and called on Europe to take action to encourage growth.

The downgrade spooked financial markets, forcing fellow eurozone struggler Italy to pay the highest yield since January to sell 10-year bonds as investors worried about the economic outlook in the bloc’s indebted states.

Analysts said the €5.95 billion Italian auction went well under the circumstances, but Rabobank strategist Richard McGuire said the 5.84 per cent 10-year yield “leaves a question mark over how long Italy will be able to finance itself at levels that can be deemed sustainable”.

Italy’s main banking association said the economy may contract by 1.4 per cent this year, more than the government’s 1.2 per cent forecast.

Spanish bank shares dropped more than three per cent after the downgrade before turning positive in the late morning after the Italian auction. Spain’s country risk, as measured by the spread on yields between Spanish and German benchmark government bonds, spiked before leveling off.

Spain has slipped into its second recession in three years and fears it cannot hit harsh deficit cutting targets this year have put it back in the centre of the debt crisis storm, pushing up its borrowing costs.

The government has already rescued a number of banks that were too exposed to a decade-long construction boom that crashed in 2008, and investors fear vulnerable lenders will be hit by another wave of loan defaults due to the slowing economy. “It’s a very challenging situation. I don’t think that the banks are cornered yet, but the government must come out soon to say how they will address them,” said Gilles Moec, an economist with Deutsche Bank.

S&P’s head of European ratings, Moritz Kraemer, told Reuters Insider television that Spanish banks could need state aid and the country faced further downgrades if its debt troubles continue to escalate.

“It is not going to be an easy job for most Spanish banks to find funding in the market. So the state may be called for at some point but that, for now at least, is something the Spanish government seems to be unwilling to contemplate,” he said.

Spain continued to rule out any use of European funds to recapitalise its banks, weighed down by bad property loans.