Spain - just above junk status

“Inflationary pressures may be easing” - as the world economy sinks into a deflationary depression.

Spain's credit rating downgraded by Fitch as international bailout looms

Europe's fourth largest economy now hovering just above junk status with credit agency blaming policy elite for deepening crisis

the Guardian,

7 June, 2012

The ratings agency Fitch delivered a strong rebuke to Europe's policy elite tonight when it sharply downgraded Spain's creditworthiness and moved the eurozone's fourth-biggest economy a step closer to an international financial bailout.

Fitch said mistakes at a European level that had allowed the debt crisis to escalate were in part to blame for its decision to cut Spain's credit rating by three notches to just above junk bond status.

The move – which follows the pattern that led to Greece, Ireland and Portugal needing help from Europe and the International Monetary Fund – makes it harder and more expensive for Spain to borrow money on the world's financial markets.

Fitch, which also served notice to George Osborne that the UK faced losing its AAA status if the double-dip recession intensified, cited the ballooning cost of bailing out Spain's struggling banks and a longer-than-expected slump for the downgrade from A to BBB.

"The dramatic erosion of Spain's sovereign credit profile and ratings over the last year in part reflects policy missteps at the European level that, in Fitch's opinion, have aggravated the economic and financial challenges facing Spain as it seeks to rebalance and restructure the economy," the agency said.

"The intensification of the eurozone crisis in the latter half of last year pushed the region and Spain back into recession, exacerbating concerns over sovereign and bank solvency. The absence of a credible vision of a reformed EMU and financial 'firewall' has rendered Spain and other so-called peripheral nations vulnerable to capital flight and undercut their access to affordable fiscal funding."

Amid growing fears for the health of Spanish banks that lent aggressively to fund the country's property bubble, Fitch said it believed the recapitalisation of the struggling financial sector would be €60bn (£49bn) – double its previous estimate.

"Spain is forecast to remain in recession through the remainder of this year and 2013, compared to Fitch's previous expectation that the economy would benefit from a mild recovery in 2013," the agency said. It added that Spain had been especially vulnerable to a deterioration in Europe's debt crisis because it had a high level of foreign debt and it suffered from a lack of investor confidence in the ability of Madrid to get to grips with the country's budget deficit and restructure the banks "in a timely fashion".

Fitch said that Spain remained at risk of a further downgrade and that its new BBB rating was based on the assumption that it would get help from Europe to bail out its banks, although not necessarily the sort of strings-attached package required by Greece, Ireland and Portugal.

Meanwhile, Ed Parker, a sovereign ratings analyst, said Fitch would "expect" to cut the UK rating if there was a "further material downturn" in the UK economy. His comments came as the Bank of England left policy unchanged at the monthly meeting of its monetary policy committee and the regular snapshot of services came in more strongly than the City had been expecting.

Although some analysts had been expecting Threadneedle Street to respond to the deepening crisis in the eurozone with steps to shore up flagging UK growth, the MPC left the cost of borrowing on hold at 0.5% and did not add to the £325bn of asset purchases that have boosted the money supply over the past three years.

Analysts said the "stickiness" of inflation – which remains a percentage point above the government's 2% target – and the relative resilience of the service sector were likely to have been factors behind the Bank's decision to sit tight this month.

Over the past few weeks, MPC members have been playing down the prospect of further stimulus unless an escalation of the euro crisis worsens Britain's economic prospects, with only one member backing more quantitative easing at the May meeting.

Economists said today's decision was likely to have been a closer-run affair and expected more QE over the coming months. Lee Hopley, chief economist at EEF, the manufacturers' organisation, said: "The decision to hold steady on policy was largely expected but, with a range of indicators for the UK economy on the slide, this is likely to be a wait-and-see position. The risks to growth seem to be building and another expansion in asset purchases may be called on ."

The Purchasing Managers' Index from the Chartered Institute for Purchasing and Supply/Markit remained unchanged at 53.3 for last month – safely above the 50 mark that separates expansion from contraction. The strong showing contrasted with a sharp drop in confidence among manufacturers. However, analysts said that with construction also weak, there was little sign that the recession-hit UK was bouncing back strongly.

"It's hard to get away from the fact that the UK economy remains relatively fragile," said Paul Smith, economist at Markit. He added that transport and communications firms had seen strong output, whereas financial services – heavily exposed to the turmoil in the eurozone – had stagnated.

Howard Archer of consultancy IHS Global Insight said: "Given the dominant role of the services sector in the economy, the steady growth in May reported by the purchasing managers is welcome news and supports hopes that it can avoid further contraction in the second quarter."

He added that the latest British Retail Consortium survey had suggested that May was a better month than rain-soaked April.

The Bank conceded in its last quarterly inflation report that inflation was likely to stay higher, for longer, than it had thought. But the PMI survey also showed that costs in the services sector were rising at the slowest pace since 2009, suggesting that inflationary pressures may be easing.