Is Rajoy Serious or is He Just Flirting?

A Spanish newspaper is reporting today that a formal request for EFSF aid for domestic banks can come as early as this week. This would be seen to clear the way for the payment of the first tranche of the 100 bln euro bank aid package that had been previously earmarked. That in turn could help meet the conditionality outlined by Draghi that would allow the ECB to buy Spanish bonds.

Rajoy himself continues to keep his card close to his vest. After meeting with the King earlier, Rajoy said that his decision still depends on knowing how the mechanism will work and the new conditions associated with ECB bond purchases.

Pressure on Rajoy to act is mounting. Today the central bank confirmed that Spanish bank dependence on the ECB continues to grow. Spanish bank borrowing from the ECB rose to 376 bln euros in July from 337 bln euros in June. Spanish banks account for a full third of borrowings from the ECB.

Despite some backing up in Spain's 2-year note in recent days, it is some 280 bp below the peak recorded on July 25. At about 4.21% the yield matches its 100-day moving average. The 10-year yield is about 100 bp lower than the July 25 peak. Yet, foreign investors do not seem inclined to return to the Spanish market. Central bank figures show that the 81 bln euros of their government bonds Spanish banks have bought this year (Jan-June) barely offsets the foreign selling (78 bln euros).

Several issues remain unclear. As Portugal and Ireland's experience suggest, EFSF aid agreement is not necessarily the same as an agreement for bond purchase from the EFSF or the ECB. The amount of funds that Spanish banks need cannot be calculated until after the auditors report due next month. Merkel is to meet Rajoy on September 6. Given Rajoy's dalliance, the decline in Spanish yields and a light supply schedule, he is likely to try to hold out longer.

Rajoy's comments themselves support the idea that the two decisions--EFSF funds for Spanish banks and bond purchases. Rajoy explains that he sought funds for the recapitalization of Spanish banks "because it seemed reasonable"..."and now, if it seems reasonable, we will do the same" [request EFSF bond purchases]. "As is logical, until we know what we are talking about [conditions], we will aren't going to take any decisions." If truth be told those conditions do not appear to have been decided yet. Draghi has hinted that the mechanism will be developed in ECB committees. Our conclusion then is that Rajoy is most likely continuing to flirt.