Now Spain's in trouble

Equity markets' rebound continued this week despite more ominous developments in Europe. Ratings agency Moody's downgraded Greek government debt to junk status. This merely confirmed what everyone has realised, but still caused another sell-off in Greek bonds as they fell out of various investment-grade bond indices and funds tracking the indices duly sold them.

More significantly, Spain was back in the spotlight. This week it had to pay almost 1% more to issue 18-month sovereign debt than last month. And its banks have been shut out of the debt markets: they had to resort to borrowing €86bn from the European Central Bank in May twice as much as just before Lehman's collapse two years ago.

What the commentators said

Spain is in trouble, said David Oakley in the Financial Times. Its banks are on the brink of a funding crisis. Investors are worried that the financial sector is riddled with bad debt from the property collapse, while the government's overall debt pile shooting up has limited scope for rescuing the banks. The sickly economy and the fact that the government has yet to make the banks reveal their losses only add to the uncertainty dogging the sector.

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With borrowing costs creeping ever higher, it is looking more and more likely that Spain could eventually have to tap the eurozone's €750bn backstop facility, according to Domenico Crapanzo of Jefferies. That would further undermine investors' "already shattered confidence", said Oakley.

The broader issue is the vicious deflationary spiral Spain has got stuck in, said Ambrose Evans Pritchard in The Daily Telegraph. Austerity measures to lower debt are weakening the economy, undermining government revenue and thus further denting confidence in the country's solvency. Like all the peripheral states, Spain is essentially "trapped in depression". Thanks to its membership of the euro, there is no scope for lowering rates or boosting growth with a lower currency.

Nor can the southern states count on buoyant growth elsewhere to lift their fortunes. Rattled by spiralling interest rates on debt, governments across Europe are embracing austerity "as the glum new orthodoxy", said Lex in the FT.

That includes heavyweight Italy, whose cuts could shave 0.5% off its growth rate, according to the Bank of Italy. Germany's cutbacks amount to 0.5% of GDP. This increases the danger of Europe falling back into recession, said Lombard Street's Gabriel Stein. That, of course, will only make markets worry even more about eurozone governments and banks.