The pain in Spain is still not on the wane as the final estimate of Spanish GDP showed today (confirmed as -0.3%). Adding this to a rebased graph of post-Lehman GDP performance shows that Spain is some way from recovering towards its pre-crisis level of production. The graph below it shows the cost of borrowing in the bond market for various countries. Some trends within this group are clear: The US and Germany have the strongest growth and the lowest cost of borrowing. Spain and Italy are amongst the weakest growth and have the highest cost of borrowing.
The obvious outlier is the UK which has one of the weakest recoveries and the strongest bond markets. There are factors beyond simple economic growth which explain the credit risk banks believe is being taken. The main one in Spain’s case would be the contingent liabilities – namely the cost of recapitalising the banking system which is set to collapse under the weight of bad real estate loans.
|Source: Brewin Dolphin, Bank of England, Datastream|
Conversely the mitigating feature for the UK is that investors in the gilt market remain confident that they will not suffer a default. Provided any deterioration in public finances is met by further austerity, the balance of fiscal policy is likely to remain deflationary. That provides the excuse, if such excuse were needed, for the Bank of England to loosen monetary policy which provides a lift for the gilt market. Given that the MPC is closing in on unanimity in its aversion to more QE, that could prove a problem if the government does decide a Plan B infrastructure push is justified. However, yesterday’s inflation report did suggest inflation would be below target at the end of the Bank’s two year forecast period, provided a glimmer of hope for those wanting further monetary support.
Head of Portfolio Strategy