Fitch downgrades Spain, ECB warns of contagion

Reuters | Sat May 29, 2010 | 3:11am IST

Spanish flag Fitch downgraded Spain’s credit rating on Friday, a day after the country adopted austerity measures, demonstrating the difficulty of steering out of the euro zone debt crisis with budget cuts that restrict growth. The widely anticipated downgrade followed a warning by a European Central Bank policymaker that Europe’s predicament could spread to other regions while labor unions threatened strikes and investment banks were hurting. Spain’s parliament approved a 15 billion euro ($18.4 billion) spending cut on Thursday, following the lead of Greece, Portugal and Italy in trying to ease a crisis that has undercut the euro, rattled banks and threatened European cohesion. The euro has fallen nearly 8 percent versus the U.S. dollar in May, and gold hit a record high earlier this month as investors searched for a safe haven.

On Wall Street, the Dow and the S&P 500 both fell more than 1 percent on Friday, contributing to the worst monthly decline for the indexes since February 2009. The Fitch downgrade "definitely spooked the market, no doubt about it," said Terry Morris, senior equity manager for National Penn Investors Trust Company in Reading, Pennsylvania. Spain’s cuts have angered labor unions and Fitch Ratings cited lower economic growth resulting from "a lower level of private sector and external indebtedness" in knocking the country’s rating to AA+ from AAA. Standard & Poor’s downgraded Spain last month but put its outlook at negative while Fitch rated it stable. "Stable? Spain should be downgraded multiple notches," said Win Thin, senior currency strategist at Brown Brothers Harriman in New York. 

"Spain is the 800-pound gorilla in the room. Greece and Portugal are small countries, but Spain is about five times their size with regards to GDP." Talks between Spanish unions and business leaders on labor reform ended without success on Friday and the Economy Ministry cuts its GDP growth forecasts. If the Spanish government fails to broker agreement between labor unions and business leaders by Monday, the government may ram through changes to labor laws anyway despite a threat by unions to hold a general strike. "I am aware that things are not going too well and it is possible that the government will have to reform the labor market through a royal decree," the parliamentary spokesman for the governing Socialists, Jose Antonio Alonso, told Spanish radio.


While Spain struggled to keep its economy in order, European Central Bank policymaker Lorenzo Bini Smaghi of Italy accused Germany of exacerbating the crisis with alarmist language, and said Europe’s predicament was an early signal of similar problems in other regions. "Just look at the screens and you’ll see the contagion under way, spreading not only to peripheral countries but also to the largest euro area countries and through the financial system," said Bini Smaghi, one of six members of the ECB’s executive board. Investors are measuring the strength of street protests across the continent, which so far have been muted. Trade unions, meanwhile, face a difficult choice: acquiesce to austerity measures and infuriate members or fight them with strikes and risk a market backlash that could make the economic situation worse.

France signaled on Friday it would go ahead with plans to raise the retirement age after unions failed to rally enough street power against the reform of a costly pension system. "Whether one regrets or welcomes it, one must say the idea of necessary sacrifice is advancing," wrote the French left-wing daily Liberation. Austerity programs and labor reforms are widely seen as vital to underpin the $1 trillion emergency fund set up by richer members. Germany, furious at having to pay for profligate nations, further alienated EU partners by unilaterally imposing a ban on naked short settling of certain securities. Germany indicated on Friday that it would make permanent some of the bans on short selling — uncoordinated with euro zone partners that triggered falls in stocks and the euro last week.


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