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Legal & General Shuns Spain Until ECB Buys Bonds: Euro Credit

Legal & General Shuns Spain Until ECB Buys Bonds
The ECB has bought Irish, Portuguese and Greek securities, though not Spanish, according to traders with knowledge of the situation who declined to be identified. Photographer: Hannelore Foerster/Bloomberg

Legal & General Investment Management won’t lend more of its $500 billion to Spain unless the European Central Bank takes the lead by buying the nation’s bonds.

The extra yield investors demand to hold Spain’s 10-year debt rather than German bunds climbed to a euro-era high on Nov. 30 as Ireland’s bailout stoked speculation that more nations will seek aid from the European Union. The ECB has bought Irish, Portuguese and Greek securities, though not Spanish, according to traders with knowledge of the situation who declined to be identified because the transactions are confidential.

“Spain has a lot of funding to do and its problems aren’t going away any time soon,” said Jonathan Cloke, an investment manager at Legal & General in London. “We don’t believe the ECB has bought any Spanish debt yet. Our strategy might change if we were to see ECB become an aggressive buyer of Spanish bonds.”

A rescue for Spain, with an economy almost twice the combined size of Greece, Portugal and Ireland, risks overwhelming the region’s 750 billion-euro ($1 trillion) bailout facility. The country has to repay about 45 billion euros of bonds in 2011, up from 32 billion euros this year, with an initial 15.5 billion euros due in April.

The ECB has stepped up buying bonds from the region’s most indebted countries to prevent the market rout from spreading. Last week it bought at least 1.965 billion euros ($2.61 billion) of bonds, the most in 22 weeks, according to central bank data published yesterday.

Shunning Spain

LGIM, the fourth largest U.K. investment fund according to data compiled by Bloomberg, is more pessimistic about Spanish bonds than Irish and Portuguese securities in which it has a neutral position. That means the proportion of Irish and Portuguese debt in the fund’s holdings matches the level in the index it uses to measure performance. The fund has an underweight position “mainly in Spain,” Cloke said.

Spain’s benchmark 10-year bond had its biggest one-day drop since the euro’s inception in 1999 on Nov. 29 as the Irish bailout overshadowed Prime Minister Jose Luis Rodriguez Zapatero’s progress in curbing his country’s budget deficit. Spain’s yield premium to German bunds was about 230 basis points yesterday, triple the average level during 2009 and close to the Nov. 30 high of 298. It was at 224 basis points today at 4:15 p.m. in London.

Any ECB purchase of Spanish bonds “is unlikely at the present time because it would be a very large commitment,” Cloke said. “At some stage, the market might want to push the yield spread to test the ECB’s resolve to find out at what level they really do care.”

Greek Disclosure

Europe’s sovereign debt crisis came to a head last year after Greece’s newly elected socialist government said its budget deficit was twice as big as the previous administration had disclosed. The sell-off of euro peripheral bonds accelerated in October after German Chancellor Angela Merkel called for bondholders to share losses with taxpayers.

Spain’s deficit will be 9.3 percent of gross domestic product this year, according to European Commission forecasts published on Nov. 29. It’s the third largest in the euro area after Ireland and Greece.

Spain stepped up efforts to reduce the deficit and gain investors’ confidence last week. The government announced the sale of almost half of its airport operator Aena-Aeropuertos and a 30 percent stake in the state lottery business. Zapatero also told lawmakers a one-time 420 euro-per-month subsidy for unemployed workers will expire in February. Spain won’t need international aid, Finance Minister Elena Salgado said yesterday in Brussels.

Forced to Buy

Belgian Finance Minister Didier Reynders said three days ago that the region’s 750 billion-euro bailout fund could be increased to stem contagion from the crisis, breaking ranks with Merkel and French President Nicolas Sarkozy. Greek Prime Minister George Papandreou said yesterday that European policy makers “need to seriously discuss” proposals for joint issuance of bonds.

The ECB will be forced to buy Spanish bonds as concern mounts that the debt problem will worsen, according to analysts at Royal Bank of Scotland Group Plc.

“That’s ultimately necessary,” said Nick Matthews, an economist at RBS in London. “While current ECB purchases calm markets, there’s nothing to prevent contagion so the ECB will end up supporting Spain. Given all the policy options available, we think the most powerful remains bond purchasing.”

Europe’s debt crisis may result in bond restructurings in Greece, Ireland and Portugal, even as policy makers say they have weapons to avert default, Harvard University Professor Kenneth Rogoff said.

‘State of Denial’

“They can’t just be in a state of denial,” Rogoff said in a Bloomberg Television interview yesterday. “They’ve tried to guarantee everything, to say, ‘Well, Germany is behind it and the IMF is behind it, it’s inconceivable for a euro zone country to restructure.”

Spain’s efforts to cut costs will hurt the economy, capping growth at 0.6 percent next year after contracting 0.3 percent in 2010 and 3.7 percent in 2009, according to the median forecast of 19 economists compiled by Bloomberg. That compares with a 3.5 percent growth rate this year and 2.1 percent in 2011 for Germany.

“Next year, we are going to focus on economic growth which is important, especially for Spain,” Cloke said. “There remain many doubts about the health of the banking system and growth is likely to be mediocre next year. Growing out of its debt burden is not going to be easy.”

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