Fiscal austerity in the developed world represents a paradox. On one hand, it is necessary as governments had already borrowed too much going into the crisis and can thus no longer continue to lever up to compensate for private deleveraging. On the other hand, the objective of fiscal austerity is to stabilise exploding government debt to GDP ratios, but this is proving difficult as depressing government spending leads to a higher decline in GDP relative to the reduction in the gross debt level.
In our view, the Spanish banking system is in need of wholesale recapitalisation to deal with the sizeable losses in the country’s property market. This will likely include a bad bank provision. Before that happens, the ECB’s open market operations will mainly buy time in the form of liquidity as well as provide banks with money to exchange bad loans for lending to the government.
Despite an historic low Bank of England base rate, the spread between the standard variable rate (SVR) for mortgages in the UK and the base rate widened significantly in the aftermath of the financial crisis, and has continued to trend higher.