El Pais quotes unnamed “Spanish government and Eurogroup sources” that Spain is looking for a way to use any money left over from the €100bn already pledged by the EU for bank recapitalization for EFSF/ESM bond purchases, thus allowing the ECB to activate the OMT without a second bailout. Converting the surplus bank bailout fund into a credit line for the state would require an application to the ESM but Spain hopes to avoid more conditions beyond a stricter calendar for already agreed reforms. In fact, already a month ago Europa Press reported that the possibility to do this had been broached, but (again unnamed) “sources in the EU Commission” were clarifying that “a new Memorandum of Understanding would be needed”.

The Financial Times implies more active participation of the European Commission in Spain’s decision making, “working behind the scenes” and “helping Madrid craft an economic reform program to be unveiled next week”. According to an unnamed “senior European official”, Luis de Guindos has been personally involved in negotiations on “structural reforms long requested by Brussels rather than” fiscal measures. However, Spain is expected to miss deficit targets which could lead to additional fiscal measures being requested next month. Another “senior Eurozone official” said that since the €100bn had already been pledged, authorizing their use for a purpose other than the bank rescue would not require going back to Eurozone member states legislatures, in particular the Bundestag, and so the plan might “gain traction over time”.

Commentary from Germany

The German press focus on the story that Spain might use unplugged funds from the bank rescue programme to trigger OMT without any further conditionality. Frankfurter Allgemeine commentary is predictable (it always is). The paper says the attempt to circumvent the conditionality of the OMS was an attempt to flout the rules, but is likely to succeed as Germany is a colluding partner. Wolfgang Schauble has no interest in bringing a Spanish rescue in front of the Bundestag.

In an editorial in Suddeutsche Zeitung, Cerstin Gammelin said it would be ok for Spain to plug unused funds from a programme for a pre-cautionary credit line. But it is not ok to try to circumvent the rules of the game. She writes that the stability of Spain is in everybody’s interest. Fortunately the rules are quite simple. Spain can apply for a pre-cautionary credit line under the ESM treaty, but has to accept conditionality.

Spain yields drop again

Spain successfully issued 3- and 10-year bonds on Thursday, exceeding the target amount and reducing 10-year yields from the previous such auction by a full percentage point to 5.70%, reportsEl Pais (English edition). The paper suggests a correlation between strong demand for the 3-year bonds and the ECB’s stated maturity limit of 3 years for eventual OMT purchases.

More opinions for and against a rescue

Advice on whether or not to apply for a rescue continues to be offered by all and sundry. BBVA President Francisco González “urged the Government to apply for ‘a precautionary credit line as soon as possible'”, El Pais reported Thursday. Francisco González also suggested BBVA might “take part” in the bad bank being created, “by transferring troubled assets or by putting in capital”.

Former prime minister Felipe González joined the ranks of those who urge Rajoy to make up his mind without prejudging whether there should be a rescue application, though he praised the ECB’s plan as “very intelligent”, reports Diario Progresista. Felipe González said he did not believe Rajoy is deliberately delaying a decision until after the Galician elections (on October 21), as “that price was already paid” with the Andalusian elections in March, and “the Government is responsible”. However, he doubted that the government knows what it should do.

Speaking against a rescue, the current PSOE and opposition leader Alfredo Pérez Rubalcaba said in a TV interview on Monday that he would not ask for one as it “would affect the Spain brand and would imply more social cuts”, as reported by ABC. Rubalcaba criticized “European economic policy” on the grounds that cuts are leading to recession and what’s needed is “a growth policy to create employment”. He also asked for “a reasonable calendar” to meet deficit goals.

Discussions under way for an official sector debt writedown for Greece

Peter Ehrlich has the story in Financial Times Deutschland, according to which talks are underway for a writedown of official sector credits to Greece. These are discussions at the moment, with no decisions imminent. The talks concern the first bilateral programme to Greece from 2010 to 2011, which totalled €53bn. One of the technical attractions of this solution is that such a debt reduction would not require the ascent of the Bundestag – an oversight of the hastily arranged Greek loan two years ago. The head of Commerzbank, Martin Blessing, also yesterday supported another Greek debt restructuring.

(Readers may have notice that the need to circumvent the Bundestag clearly play a big role in the discussions both on Spain and on Greece. Our view is that the most likely effect is to increase the euroscepticism among German MPs and the public. )

Greek coalition partners still battle over €2bn in cuts, voiced frustration over troika tactics

The Greek coalition moved closer towards an agreement in late night talks on Thursday but are still short of a final deal over some €11.5bn in savings demanded by international creditors. Reuters quotes a senior official saying that late night talks secured agreement on several points including the symbolically important step of raising the pension age to 67 years. Their source said an agreement at the technical level might come as soon as Friday after which the troika leaders could leave to prepare their report. Kathimerini reports that the three leaders will meet again middle of next week while Yannis Stournaras is expected to continue negotiations with troika envoys Sunday. Socialist PASOK leader Evangelos Venizelos and Democratic Left chief Fotis Kouvelis publicly expressing frustration with the troika’s tactics while Samaras reportedly gave vent to similar sentiments behind closed doors.

Reuters reports that a total of €6.5bn in cuts to wages, pensions and benefit payments had been agreed and a further €1.1bn in savings were planned from an increase in the retirement age. An additional €1.9bn would come in savings from various modernisation measures approved by the troika, leaving the two sides still wrangling over some €2bn in proposed savings in health, defence and local government. Also there are reports that the troika is demanding an additional €2bn on top of the €11.5bn.

Italy cuts its economic forecasts

Il Sole 24 Ore reports that the Italian government has lowered its economic forecast, while balancing the budget in 2013 remains the linchpin of the Italian government’s programme to bring public finances under control. The balanced budget – within 0.5% of GDP – remained the anchor of fiscal policy, Mario Monti said. For that reason, he confirmed the goal of a balanced budget in 2013 despite a worse-than-expected recession, the impact of earthquakes that shook Emilia Romagna last month and the escalation of the eurozone crisis. In the new government forecasts, the economy will contract by 2.4% this year and 0.2% in 2013, versus previous estimates of -1.2% and +0.5%, respectively. The 2012 deficit forecast is now 2.6% of GDP versus a previous 1.7%, and for the next year the government is forecasting a deficit of 1.6% versus previous forecast of 0.5%. Italy’s debt-to-GDP will hit 126.4% of GDP, 127.1% in 2013. The government and the treasury confirmed the goal of selling of state assets worth 1% of GDP, or €20bn, per year, and for five years, to bring the debt down by 20%.

Grim employment data and prospects for Spain

Expansion quotes a report from AGETT, a trade organization of temporary employment agencies, saying that the number of unemployed older than 55 have quadrupled to half a million since 2007 while the unemployment rate for the age group has tripled to 16.8%. Labour force participation for this age group has been rising as well, to 22.5%. The report also says the long-term unemployed (who have been on the job market for over a year) rose to nearly 3 million. All the data are to the end of the first half of 2012.

On Wednesday, El Mundo reported that the Spanish business owners’ association CEOE is forecasting a GDP drop of 1.6% in 2012 and “similarly” in 2013, when “the economy will touch bottom”. The CEOE is also forecasting a 26.5% unemployment rate, or nearly 6 million people unemployed in 2013., over 2% above government projections. The 2012 deficit target would not be met either.

Also on Wednesday, Mariano Rajoy proclaimed in a Parliament debate that his policies would “soon” generate growth and employment, and blamed the “inheritance” from the previous PSOE government for the current situation, as reported by Europa Press.

Rajoy and Mas scenify their disagreement

The Guardian reports that Mariano Rajoy rejected the demands for greater fiscal autonomy by Catalan premier Artur Mas at their meeting in Madrid Thursday. Artur Mas did not announce early regional elections as had been anticipated, though it is still thought likely that there will be elections at the end of November or early December. On his return to Barcelona, Mas was received by a crowd chanting for “independence”. An editorial in El Pais advocates moving towards federalism in Spain, and demands that Rajoy and Mas work towards a common position to “evolve the regional system”.

French government is piling on the pressure on Socialist MPs

Jean-Marc Ayrault is increasing the pressure to get Socialists to back the fiscal pact, saying that abstaining would be as unacceptable as an outright No vote.  Socialist group leaders in both the senate and the National Assembly warned that MPs cannot simultaneously support Hollande and vote against the pact. Out of 300 Socialist MPs, 15 to 25 oppose openly the treaty. Not much, but enough symbolically to worry about, writes Guillaume Tabard in his blog for Les Echos. Among the Greens, scepticism reigns. The minister for relations with the parliament estimates that half of the Greens will vote against, one quarter will abstain and one quarter will vote for the fiscal pact. Politically it would be a disaster if the government has to rely on the conservatives to secure the vote, according to Tabard. He also warns that if as currently discussed there are two votes, one political declaration ahead of a vote on the fiscal pact itself, the likelihood increases that deputies vote yes in the first, feeling free to vote “no” in the second vote.

Katainen says banking union ain’t gonna happen this year

Reuters reports that Jyrki Katainen has cast doubt on a banking union this year. He said a banking union must not be abuse to deal with sick banks. He said it would be very hard indeed to set it up this year. Erkki Liikanen also emphasised the need for a banking union not be constructed as a transfer mechanism between good banks and bad banks.

Cœuré calls for a “passive” fiscal policy

This is quite an extraordinary speech from an ECB board member, and perhaps an indication of a tectonic shift current taking place in European central banking (outside Germany of course, where nothing has shifted). Business Insider quotes the part of Benoit Cœuré’s speech where he demands a different type of fiscal regime than the one outlined under the Maastricht Treaty:

“To borrow from Leeper’s terminology, this means that an “active” monetary policy – namely a monetary policy that actively engages in the setting of its policy interest rate instrument independently and in the exclusive pursuit of its objective of price stability – must be accompanied by “passive” fiscal policy. A passive fiscal policy means that the fiscal authority must be ready and willing to adjust its policy stance (revenues and primary spending) in such a way as to stabilise its debt at any level of the interest rate that the central bank may choose. Or, to put it another way, borrowing from Woodford’s terminology, fiscal policy needs to be ‘Ricardian’.”

Pisani-Ferry and Wolff’s five-step guide to banking union

Writing in the Financial Times, Jean Pisani-Ferry and Guntram Wolff lay down five principles for a successful banking union. The first and most important is that it must be comprehensive. Common supervision without fiscal backstop means member states pay for the mistakes of the ECB. A common fiscal backstop without resolution powers would create moral hazard. The second is not to burden the new system with legacy problems. The third is to focus on what matters – i.e. don’t try to merge Germany’s six deposit insurance schemes. The forth is to plan for the worst;
And finally, the fiscal backstop needs to be designed with a strong institutional set-up that is robust to withstand major crises.

10-Y Spreads, Forex, ZC Swaps and Euribor-Ois

Spanish are up again overnight as markets are confused about what’s going on.

10-year spreads
	Previous day	Yesterday	This Morning
France	0.675	0.730	0.734
Italy	3.314	3.611	3.563
Spain	4.127	4.231	4.328
Portugal	7.114	7.148	7.330
Greece	18.794	19.055	-1.60
Ireland	3.499	3.477	3.662
Belgium	1.063	1.118	1.100
Bund Yield	1.603	1.547	1.595
Euro Bilateral Exchange Rate
	Previous	This morning
Dollar	1.297	1.2998
Yen	101.390	101.58
Pound	0.800	0.7995
Swiss Franc	1.209	1.2102
ZC Inflation Swaps
	previous	last close
1 yr	1.99	1.95
2 yr	1.77	1.75
5 yr	1.92	1.92
10 yr	2.21	2.2
Euribor-OIS Spread
	previous	last close
1 Week	-8.314	-8.614
1 Month	-3.243	-3.443
3 Months	5.186	4.986
1 Year	60.014	61.014
Source: Reuters