Europe Austerity Push Deepens After Rescue Message

Spain and Portugal may be getting the message as they try to stop their economies from becoming infected by the Greek crisis.

Two days after other European governments told them to fix their budgets in return for a $1 trillion backstop, Spanish Prime Minister Jose Luis Rodriguez Zapatero yesterday announced the biggest round of budget reductions in 30 years. In Portugal, Finance Minister Fernando Teixeira dos Santos says he’s prepared for “social tension” after announcing additional cuts.

Policy makers are running the risk of union opposition as they force through austerity measures to convince investors they won’t join Greece in asking for an international bailout. While some economists said the European Union lifeline could take pressure off deficit-laden nations to act, it was enough to prompt Zapatero to announce a 5 percent cut in public wages.

“The fiscal announcements serve to suggest that the momentum now is indeed towards fiscal cuts,” said Erik Nielsen, chief European economist at Goldman Sachs Group Inc. in London. “What we have in the euro zone policy space right now is ‘moral suasion,’ not ‘‘moral hazard.’’’

The yield on Spain’s two-year government bond dropped 12 basis points to 1.861 percent yesterday after rising to a euro- era high of 3.143 percent last week. Portugal saw more demand at a sale of 1 billion euros ($1.3 billion) of 10-year bonds yesterday, with the debt priced to yield 4.52 percent, down 181 basis points from the May 7 high.

Photographer: STR/AFP/Getty Images

Spain's Prime Minister Jose Luis Rodriguez Zapatero gives a speech at the Parliament in Madrid on May 12, 2010. Close

Spain's Prime Minister Jose Luis Rodriguez Zapatero gives a speech at the Parliament in... Read More

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Photographer: STR/AFP/Getty Images

Spain's Prime Minister Jose Luis Rodriguez Zapatero gives a speech at the Parliament in Madrid on May 12, 2010.

Turning Point

Zapatero’s cuts were welcomed by Spain’s two largest banks, Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA, even as they provoked the largest union, Comisiones Obreras, to say it plans a ‘‘massive” response to the “unjust” measures.

The planned deficit reduction, to 6 percent of gross domestic product in 2011 from 11.2 percent last year, would be the largest two-year cut since at least 1980.

“This is a turning point,” said Fernando Fernandez, a professor at the IE business school in Madrid and a former International Monetary Fund economist. “The prime minister has had a fright and come down to earth at last to understand the reality and what’s at stake here.”

The euro headed for its first advance in three days, rising 0.2 percent to $1.2643 as of 9:19 a.m. in Tokyo. The currency reached a 14-month low of $1.2529 on May 6.

U-Turn

Zapatero’s plan, which marks a policy U-turn for the Socialist premier, came as the European Commission outlined new proposals for governments to “decisively” toughen budget rules and impose swifter penalties on nations that break them.

The 27 EU members should reinforce fiscal surveillance, improve compliance with the bloc’s budget rules and focus more on cutting public debt, the Brussels-based commission said yesterday. Governments are required to keep their deficit below 3 percent of GDP.

Those repeatedly breaching the rules should face “more expeditious treatment,” it said.

EU Economic and Monetary Affairs Commissioner Olli Rehn said the Spanish cuts “seem to go in the right direction,” as the nation renewed a pledge to meet the deficit limit in 2013. The steps include a 6 billion-euro reduction in public investment, a pension freeze and the end of a 2,500-euro subsidy for new parents.

Dos Santos said that further steps to cut spending and raise revenue are planned.

Spain and Portugal are bracing for opposition from unions one week after Greek demonstrators torched buildings in Athens, leading to three deaths.

New Relationship

The approach marks a change for Zapatero, who told workers in 2005 he slept with his union card by his bed and who has tended to consult workers’ representatives before announcing policy shifts. Spain’s last general strike was in 2002, when the People’s Party was in power.

The move “marks a change in relations” between workers and the administration and protests will follow, said Candido Mendez, secretary general of UGT, the country’s second-biggest union.

In Ireland, 70 protesters tried to storm the country’s parliament yesterday after they broke away from a march against the government’s plans to bail out the country’s banks.

Still, demonstrations have failed to budge government policy in Greece, and Spain has managed to reorder its finances in the past.

“Spain has a very good track record of implementing austerity measures,” said Jose Garcia-Zarate, a fixed-income strategist at 4Cast Ltd. in London. “I don’t think the Spanish government suffers from the same degree of lack of credibility as Greece.”

Teixeira dos Santos, who cut Portugal’s deficit in half in the two years after taking office in 2005, says union opposition wouldn’t be an obstacle to his country’s budget plans.

“We have to take measures to cut expenditure and increase revenue” said Teixeira dos Santos. “We’ll face the social tension.”

-- With assistance from Simon Kennedy in Paris and Jim Silver in Lisbon. Editors: John Fraher, Eddie Buckle

To contact the reporter on this story: Emma Ross-Thomas in Madrid at erossthomas@bloomberg.net

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