Now it' Spain's turn to depress the euro

09/14/2010 6:49 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

More worries for the euro. This time from Spanish politics.

Prime Minister Jose Luis Rodriguez Zapatero has set a September 30 deadline for announcing his government’s budget plan. Investors want to see a combination of taxes and spending that reduces Spain’s budget deficit, the Euro Zone’s third largest. But they’re skeptical that Zapatero can deliver: Since July 27, the spread between the benchmark 10-year German bund and the Spanish 10-year bond has widened by 0.3 percentage points to 1.79 percentage points. The spread’s historic high since the introduction of the euro came on June 16 at 2.21 percentage points.

The skepticism is well founded. Zapatero heads a minority government that depends on the votes of six members from the country’s Basque Nationalist Party, which advocates separation from Madrid, and abstentions from at least one other lawmaker, to achieve a majority on the budget. If he can’t pass a budget, Zapatero’s Socialist government is likely to fall.

Which is, perversely, the reason the budget is likely to pass.  The prime minister has run a minority government since 2004, cobbling together one fleeting coalition after another. An early election, if the budget fails, would probably go to the pro-business People’s Party according to recent polls. That gives left-wing parties that have voted with Zapatero in the past incentive to find grounds for a deal again.

The real problem for Zapatero is that his own party has shown no enthusiasm for the kind of spending cuts and tax increases that the country needs to convince investors not to sell Spanish bonds and push up the interest rate that the government has to pay on its debt. The strongest action the Socialists have taken was to pass a 5% cut to public sector wages and a freeze on pensions back in May. And that only passed by one vote.

The cliff hanger will further unsettle the European debt markets, which are already pushing up the interest rate spreads on the heavily indebted countries of the Euro Zone periphery—Ireland, Portugal, Greece, and Spain.

The markets won’t rest any easier knowing that Zapatero’s union allies are planning a general strike to protest spending cuts on September 29. (For more on another poster child for the euro crisis, see my post http://jubakpicks.com/2010/09/13/dont-get-too-excited-about-the-euro-greek-crisis-still-isnt-over/ )

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