Bailout or not, Spain politics may drive euro lower

LONDON: Foreign exchange markets may be seriously underestimating the impact on the euro of political risk in Spain, regardless of whether Madrid seeks an international bailout.
The euro rose yesterday after the Spanish government unveiled on Thursday a crisis budget that many see as a precursor to a bailout request that would allow the European Central Bank to buy Spain’s bonds.
Yet a euro at $ 1.2930 may be too high. Year-end predictions, from some major houses, of euro/dollar close to $ 1.3500 could be just pipedreams.
It should arguably be trading nearer $1.2500.
Although still buoyed by hopes that the ECB’s anti-crisis measures will be a panacea for the currency bloc’s ills, the exchange rate’s current level underprices political risks, not least in Spain.
While the markets understandably focus on whether or not the Spanish government is prepared to seek a bailout, the powerful but indebted region of Catalonia is to hold elections on Nov. 25 that could also produce a vote in favor of independence.
Catalonia voted on Thursday in favor of holding a referendum on independence minutes after Deputy Prime Minister Soraya Saenz de Santamaria told reporters the national government was prepared to prevent any such vote. A vote for independence by Catalonia, which represents some 20 percent of the Spanish economy, while not precipitating a rapid break-up of Spain, would be a game changer, and markets may not yet have fully understood the significance of the possibility.
For Catalonian leader Artur Mas’s CiU party, this may be a once-in-a-lifetime opportunity to capitalize on popular local disaffection to push for full independence for Catalonia. If that is their objective, this must be their moment. While many no doubt see this as an outlier risk, others might cast their minds back to the swift break-up of Czechoslovakia in 1992. The stakes could not be higher and the issue will remain whether or not Spanish Prime Minister Mario Rajoy signs up to the ECB’s plan.
Thursday’s crisis budget in Spain may buy some time for the euro, but the new austerity measures will hurt.
Violent protests had already erupted in Madrid even before the budget with police firing rubber bullets at anti-austerity protesters who were trying to form a human chain around the Spanish parliament.
As for the budget itself, many may find the notion that the cuts it includes are compatible with a forecast that Spain’s economy will only contract 0.5 percent in 2013 hard to believe. Those who have been protesting in Spain will also probably be less than impressed by tales of 1,000 euro meals of filet mignon steak and turbot washed down with seven bottles of wine and 10 beers aboard the prime minister’s government-paid jet.
Such conspicuous consumption will surely not sit well with a Spanish people having to cope with an elevated jobless rate and austerity measures.
Rajoy has already been compared by some Spaniards to Marie-Antoinette, the ill-fated wife of Louis XVI of France, who reportedly said people should eat cake if they had no bread.
None of these political risks can be realistically portrayed as positive for the euro but they have arguably not yet been recognized as material threats to the value of the single currency by the foreign exchange market.
“Spain is the problem, Europe is the solution,” was the view of the early 20th century Spanish philosopher Jose Ortega y Gasset.
Spain may still be the problem but local politics may mean Europe, this time, can offer no lasting solution.
The euro/dollar exchange rate arguably does not reflect the true political risks to the single currency.

— Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own