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Rajoy Risks Riling ECB in Bid to Avoid Union Ire: Euro Credit

Photographer: Dominique Faget/AFP/Getty Images

Government employees demonstrate against the government austerity measures in Madrid, on July 25, 2012. Close

Government employees demonstrate against the government austerity measures in Madrid, on July 25, 2012.

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Photographer: Dominique Faget/AFP/Getty Images

Government employees demonstrate against the government austerity measures in Madrid, on July 25, 2012.

Spanish Prime Minister Mariano Rajoy risks irking the European policy makers he needs on his side after he extended unemployment benefits to avoid stoking social unrest.

Rajoy said yesterday his government will continue to make payments to the long-term unemployed, extending for six months a benefit adopted by his Socialist predecessor three years ago that was due to expire today. Rajoy, who reiterated he may consider seeking European help to tame 10-year bond yields hovering near 7 percent, didn’t say how he’d pay for the measure he described as “just.”

The premier is trying to head off protests from Europe’s largest army of unemployed as his popular support sinks. The plan to increase spending two weeks after European Central Bank President Mario Draghi offered to wade back into bond markets threatens to undermine his best way of bringing down borrowing costs from near levels that prompted Greece, Portugal and Spain to seek bailouts.

“He’s going to provoke an angry response and make the ECB even less willing to provide support,” said Stuart Thomson, a fund manager at Ignis Asset Management in Glasgow, who expects Spain to seek external funds by the end of the year. “Why poison the negotiations with resistance and decisions that will annoy the northern Europeans?”

Photographer: Jaime Reina/AFP/Getty Images

Spain's Prime Minister Mariano Rajoy during a news conference after meeting with King Juan Carlos of Spain at the Marivent royal residence on the island of Mallorca, on Aug. 14, 2012. Close

Spain's Prime Minister Mariano Rajoy during a news conference after meeting with King... Read More

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Photographer: Jaime Reina/AFP/Getty Images

Spain's Prime Minister Mariano Rajoy during a news conference after meeting with King Juan Carlos of Spain at the Marivent royal residence on the island of Mallorca, on Aug. 14, 2012.

Strict Conditions

Spanish 10-year bond yields dropped 1 basis point to 6.72 percent as of 9:26 a.m. in Madrid today compared with 6.73 percent yesterday and a euro-era intraday record of 7.75 percent on July 25. They have fallen 44 basis points since Aug. 2, when Draghi said the ECB was prepared to buy sovereign bonds to bring down yields if countries applied for similar support from Europe’s rescue fund and accepted strict conditions. Rajoy said the next day he would consider triggering the mechanism if it were “in the best interest” of Spaniards. He reiterated those comments yesterday.

ECB policy makers have complained that previous attempts by the central bank to bring down borrowing costs have led politicians to ease pledges to implement budget cuts and measures to overhaul their economies. The ECB briefly bought Spanish and Italian bonds last year.

“We haven’t forgotten what happened in August of last year: We bought Italian bonds and right after that the Italian government reneged on its pledges,” ECB Governing Council member Luc Coene said in an interview with De Tijd and L’Echo on Aug. 11 “The conclusion is clear: When you take away the market pressure, you take away the pressure on politicians to act.”

Costs Unknown

Under the extension announced by Rajoy, Spaniards who have run through as much as two years of contributions-based jobless benefits will continue to receive 400 euros ($494) per month. The government hasn’t given an estimate of the price tag of extending the program, which cost 642 million euros for six months at its inception in 2009 when the jobless rate was 18 percent. More than 200,000 people were getting the aid as of June, the Labor Ministry said yesterday.

Rajoy popular support is slumping, while the two biggest unions are talking about a “hot autumn,” starting with a nationwide protest march to converge on Madrid on Sept. 15. A poll published July 23 by newspaper El Mundo found that Rajoy’s People’s Party would win 36 percent of the vote, down from 45 percent at the Nov. 20 general election.

Backing for the government, which has an outright majority in Parliament, is declining as Spaniards suffer the third year of spending cuts and a deepening recession that’s pushed the unemployment rate to almost 25 percent, leaving 1.7 million homes with no breadwinner.

The latest package of 65 billion euros of budget reductions, announced after the European Union gave Spain an extra year to meet its deficit goals, included trimming the main jobless benefit and raising the value-added tax in breach of Rajoy’s election pledges.

Deficit Goals

The government risked a “confrontation with the unions” if it didn’t roll over the subsidy, said Gilles Moec, co-chief European economist at Deutsche Bank AG in London. The payment plan “probably isn’t central for Spanish public finances,” as the nation aims to cut the deficit to 6.3 percent of gross domestic product this year from 8.9 percent last year, he said.

“I would hope the ECB wouldn’t focus on that,” he said.

Rajoy’s track record with European colleagues and investors may make the decision more important than it would be otherwise, Ken Wattret, chief European economist at BNP Paribas SA, said in a telephone interview.

Rajoy surprised investors and European allies in March when he unilaterally changed Spain’s deficit target hours after signing a pact on budget coordination in the euro region. Calls from members of his government for the ECB to buy the nation’s bonds have also prompted criticism from central bank policy makers for encroaching on the bank’s independence.

“The problem is that the government’s credibility has been damaged by the way it’s handled a number of issues,” Wattret said. “Something that ordinarily might be seen as unimportant from the ECB’s perspective might be seen as more important now because of the mistakes the government has made in the past.”

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

To contact the editor responsible for this story: Tim Quinson at tquinson@bloomberg.net

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