The Spanish Prime Minister sparked concern across the eurozone yesterday after apparently ruling out a Greek-style bailout that would force Madrid to make specific budget cuts.
Mariano Rajoy's resistance could stand in the way of a much-anticipated rescue of the country, which is struggling to bring its finances under control. After facing eye-watering borrowing costs over the summer, Spain is seen as a prime candidate for assistance under the European Central Bank's new bond-buying scheme, which is meant to bring down the punitive interest rates faced by debt-laden countries in southern Europe.
But the scheme unveiled by the ECB President Mario Draghi would first force Spain to apply to one of Europe's bailout funds – something that could force Madrid to implement specific spending policies. "I will look at the conditions. I would not like and I could not accept being told which were the concrete policies where we had to cut," Mr Rajoy told Spanish television in his first interview since taking power in December.
He said he had not yet decided if the ECB scheme to buy short-term bonds was "necessary or convenient".
The country's generous state pension appears to be one key area that the PM is unwilling to cut. "The first instruction I gave to the Finance Minister who is drawing up the budget is that the people it shouldn't affect are the pensioners," he said.
The ECB announcement last week has reduced the pressure on Spanish government bonds, allowing the government to borrow at more affordable costs as it attempts to fix its finances. But the markets may turn sour in the wake of Mr Rajoy's comments, as traders had been expecting Madrid, which has already had to go cap in hand to its European partners for money to prop up its ailing banks, to apply for the ECB's help.
The Rajoy government has already raised income tax and value-added tax and pushed through billions of euros of cuts to public services including education and health. However, the PM said that pensions would not be cut in the 2013 budget.
Speaking ahead of a government review of Spanish lenders, Mr Rajoy also questioned whether or not the country's banking industry actually needed the bailout of up to €100bn (£80bn) agreed last year as it tried to cope with massive debt write-offs following a property market collapse.
Despite his words, market watchers still expect Spain to seek the help of its European partners. "The stricter the conditions, the more unwilling will Spain be to request support. Still, we see it as almost inevitable that Spain will eventually have to relent and request aid," said Bill O'Neill, chief investment officer for Europe, Middle East and Africa at Merrill Lynch Wealth Management.
As for when the dam may break, Mr O'Neill reckons that will come in mid-October, when the Spanish government has a "demanding market funding schedule".
Signs of Spanish resistance could, however, trigger a reversal in the market rally caused by the ECB announcement. "The market has been overbought in the short term after the ECB announcement," said Henrik Henriksen, the chief investment strategist at PFA Pension A/S in Copenhagen, where he helps to oversee $55bn in investor cash.
Mr Rajoy's comments come as investors nervously look forward to another crucial week in Europe, with the German constitutional court in Karlsruhe to decide today whether to stop Germany's participation in the €500bn European Stability Mechanism bailout fund. A ruling against participation could threaten the future of the euro.
Meanwhile, the Greek tragedy continued to unfold yesterday, with the Greek Prime Minister, Antonis Samaras, flying over to Frankfurt to explain to the ECB President, Mario Draghi, why he had failed to secure agreement from his coalition partners on further spending cuts.
Beyond Europe, debt woes continued to haunt the United States, which was threatened with another ratings cut – this time by the Moody's ratings agency, which said it could lower its AAA rating for the country, probably by one notch, if federal budget talks break down.
Mr Rajoy's comments come as investors nervously await another crucial week in Europe
Euro crisis: Where the states stand
All eyes will be on the German constitutional court today as it rules on whether the eurozone's most powerful member can take part in the European Stability Mechanism, the currency bloc's permanent bailout facility, which is meant to replace the European Financial Stability Facility. A nein from the court will probably send markets into a tailspin as it will cast serious doubt on the zone's ability to shore up weaker members and the single currency. However, a nod from the court's red-robed judges – which is what most analysts expect – will be far from the end of German opposition to funding bailouts, with legal challenges now being lodged against the ECB's bond-buying scheme.
If Spain is in the eurozone emergency ward, then Greece could be about to enter the morgue. The government of Antonis Samaras has failed to agree a further €11.5bn (£9bn) of cuts that the Prime Minister has said is key to securing the future of the country's bailout funding. The leaders of the three parties in the coalition government will meet today to try again to thrash out an agreement, but their main hope seems to rest on getting the EU to agree to a softening of its austerity requirements, with Mr Samaras meeting Mario Draghi, the European Central Bank chief, yesterday to plead his country's case ahead of a summit of eurozone finance ministers on Friday.
Like his Spanish counterpart, the Italian Prime Minister, Mario Monti, is believed to oppose extra conditions being imposed on his country before it can benefit from the ECB's new bond-buying scheme. Yesterday, he admitted to journalists that his government had "aggravated" the recession with its austerity measures – but said it would invest €50bn in infrastructure in the coming months. His comments came as it emerged that the second quarter for the Italian economy was worse than originally forecast, with a contraction of by 0.8 per cent between April and June, instead of the original figure of 0.7 per cent.
One of Continent's strongest advocates for pro-growth policies, President François Hollande is himself set to unveil a dose of George Osborne-style belt-tightening to keep French finances in check. Up to €30bn of tax rises and spending cuts are expected to be the key feature of France's upcoming budget. The Socialist leader also pledged to reform the labour market, in the face of union opposition, as he aims to return the economy to growth by 2014 while narrowing the fiscal deficit to around 3 per cent of economic output by next year.
Recession-hit Portugal enjoyed some rare good news yesterday with the EU and IMF agreeing to loosen budget controls imposed as part of the country's €78bn bailout. This means the government will be able to run a slightly bigger deficit than originally planned without endangering the next tranche of cash from the EU and IMF. The reprieve follows the deterioration of the country's finances following worse than expected tax revenues as the economy bumps along in its worst recession since the 1970s. Nevertheless, the government of Pedro Passos Coelho has been praised by the Troika for "staying the course" over austerity, even recently raising workers' social security contribution rates.