Politics in Spain and Italy rattle euro markets

02/04/2013 3:36 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

European markets might have been able to shrug off the latest bad news from the Spanish economy, but it looks like bad political news is taking a heavy toll. The German DAX stock index closed down 2.5% today; the French CAC 40 fell 3%; Spain’s IBEX 35 dropped 3.77%; and the Italian FTSE MIB index plunged 4.5%.

The latest numbers, released today, show an additional 132,000 workers in Spain joining the ranks of the unemployed. That takes the total officially out of work to 4.98 million, a new record.

But what seems to have really rattled the markets today is political news from both Spain and Italy that threatens to produce weak governments that would not be able to (or might not be inclined to) continue the programs of economic reform and budget austerity that have stabilized the European debt markets.

In Spain the threat comes from a corruption scandal that has already led to opposition calls for the resignation of Prime Minister Mariano Rajoy. Beginning last Thursday newspapers in Spain have published stories, based on leaked documents, saying that Rajoy received 250,000 euros in income that was then hidden from tax authorities.

On Saturday Rajoy denied the allegations in a televised speech, but that certainly didn’t stop the damage. On Sunday opposition Socialist leaders called for the Prime Minister to resign. Opinion polls released that day show that Rajoy’s Popular Party, which soundly defeated the Socialists in November 2011, has fallen into what is essentially a dead heat with the Socialists. Neither party would win a majority of votes if an election were held today.

In Italy former Prime Minister Silvio Berlusconi continues to gain support in the run up to national elections on February 24-25. It still looks like Berlusconi’s People of Freedom will not win the election, but it seems increasingly likely that whatever coalition government does succeed the unelected technocrat government of Mario Monti will be extremely weak, so weak, markets fear, that it will not be able to deliver still needed reforms.

It doesn’t help investors nerves that Berlusconi’s surge is built on a rapidly anti-euro, anti-German campaign. According to Berlusconi, the economic pain that Italians currently feel is the fault of economic policies that profit Germany and beggar Italy.

Recently Berlusconi’s promises have expanded to attacks on some of the basic reforms of the Monti government that have calmed bond markets. In a speech on Sunday Berlusconi promised to abolish the property tax introduced by the Monti government in 2011 in an effort to bring Italy’s budget deficit under control. Not only would he abolish the tax, Berlusconi said, he would refund approximately 4 billion euros paid in by taxpayers in 2012. Prime Minister Monti hit back by saying that Berlusconi “has never kept any of his promises." But the attack on the very unpopular tax will bring Berlusconi votes in the election.

Maybe enough votes to produce a hung parliament.

Spanish bonds responded by falling in price and rising in yield to 5.43% on the 10-year bond, the high since December, and 0.2 percentage points above Friday’s yield. The Italian 10-year bond rose 0.1 percentage point to a yield of 4.42%. The euro fell against the dollar to $1.3533.

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