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The Eurozone debt crisis is back in the headlines and Spain is the area to watch out for. It's 3 and 6-month bill auction earlier had weaker interest than expected. Bid-to-cover ratios were weaker than at recent auctions and yields were also higher, at 0.836% for the 6-motnh Bill, compared with 0.764% at an auction in Feb. Interestingly, 3-month yields were slightly lower than at an auction in  February at 0.381%.

While we don't want to read too much into one auction, this is an interesting development and may suggest that investors aren't as willing to hold longer term Spanish debt. This raises the bar of difficulty for Madrid as it tries to auction bonds; the next one is scheduled for 4 April. 

Also today the Bank of Spain said that the data points to a contraction in the first quarter and things could be hard until the second half of the year. The Bank had no choice but to admit this after the dismal PMI readings for March, which fell deep into contraction territory. The risk for Spain is that the EU's already dismal growth forecast for this year - it is expecting Spain's economy to contract 1.6%- could actually be larger than expected given the extent of the slowdown at the start of the year.

It's a big week for Spain. Prime Minister Rajoy has to deliver the 2012 Budget on Friday and is also facing his first national strike as Prime Minister on Thursday. Added to that Rajoy failed to gain a majority in elections in Andalucía, Spain's largest autonomous region. This was always going to be a hard sell as Andalucía is traditionally a Socialist strong hold and has an unemployment rate above 30%.

Is Spain the next Greece?


It's seen deposits flee its banking sector, it's missed fiscal targets and it has seen its public debt pile surge sharply. Added to that, like Greece its economy is in the doldrums, Spain's unemployment rate is even worse than Greece's.

However, crucially for Madrid, its problems are nowhere near as bad as those faced by Athens. For example, its budget deficit last year was 8.5% of GDP versus 10.6% for Greece, and its public debt is roughly 72% of GDP, versus 160% for Greece. But, like Greece, its political structure is fairly de-centralised, which makes it difficult to apply the austerity measures to meet the targets imposed by the Eurozone's fiscal pact.

Spain's regions control healthcare and education spending, and since the on-set of the sovereign debt crisis in 2010 have failed to cut their deficits. The head of Spain's central bank said today that a solution is needed to ease the regions' liquidity problems, which suggests the central government could step in to support the regions with extra cash injections. Today we have seen further announcements on domestic bank mergers to help deal with rising bad loan levels, which have continued to rise sharply in Q4 especially for the construction and services sectors of the economy.

Thus, it's hard to see how Rajoy can deliver a Budget that can 1, deliver the required austerity (even with the re-negotiated Budget deficit target of 5.3% of GDP for this year) and 2, get growth going. The markets are likely to balk at too much in either direction, so we see the pressures rising for the euro as we progress through this week.

Market moves:

The single currency had a nice move higher on the back of helicopter Ben's dovish talk yesterday, which was enough to push it through near term resistance at 1.33. The cross has been sticky around the 1.3350 level -downtrend channel resistance that dates back to August 2011 - if it can get above here then it opens the way to 1.35 - the 100-week moving average and a level that the world and his wife in the market is looking at.

Even though we don't think more QE from the Fed is on the cards unless there is a sharp deterioration in the labour market or in the inflation picture, the markets love liquidity and the Fed's signalling power was revealed again yesterday, causing stocks to rally and the dollar to fall sharply. However, we don't see the euro gaining traction above 1.35 as there is just too much sovereign noise in the back ground and spreads between Spanish and German and (to a lesser extent) Italian and German bond yields has started to push higher after moderating at the start of the year. This is a reflection of heightened risks in the currency bloc.

We hear again from Bernanke later today at a lecture at George Washington University. All eyes will be on whether he sheds more light on the possibility of more QE, although these speeches are about the history of the Fed so we don't expect any bombshells like yesterday.

Interestingly, the Spanish bond auction didn't affect the euro too much. Gold continues to test resistance around $1,690, and European stocks continue to move higher, including Europe's bank stocks. So while there may be some follow through today from yesterday's Bernanke-inspired rally, we could get stuck at some major levels in the coming days as investors weigh up the chances for more QE from the Fed in the current environment.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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