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Zapatero Sacrifices Party as Spain Debt Beats Italy: Euro Credit

Spanish Prime Minister Jose Luis Rodriguez Zapatero
Jose Luis Rodriguez Zapatero, Spain's prime minister. Photographer: Denis Doyle/Bloomberg

Spanish Prime Minister Jose Luis Rodriguez Zapatero is sacrificing his Socialists’ hold on power at the altar of austerity.

The Socialist premier, whose constitutional amendment to ban budget deficits was approved by the Senate today, has helped push Spanish bond yields to the lowest in two years relative to Italian rates. His rollback of the social safety net, along with a jobless rate of 20.9 percent, has made People’s Party candidate Mariano Rajoy the favorite to win Nov. 20 elections, polls show.

While Zapatero sticks to budget cutting, his Italian counterpart, Silvio Berlusconi, clings to office as he retreats on austerity measures demanded by the European Central Bank as a condition for support. The ECB began buying Spanish and Italian bonds last month to prevent the debt crisis from infecting the euro region’s third- and fourth-biggest economies.

“There’s a sense in Spain that at least there’s a proper and timely reaction,” said Gilles Moec, co-chief economist at Deutsche Bank AG in London. “Zapatero, knowing that his political career is nearly over, is ready to do whatever it takes to appear as Europe’s good pupil.”

Zapatero, 51, who isn’t seeking re-election, has focused on persuading markets that Spain can avoid following Greece, Ireland and Portugal into a bailout. Spanish 10-year borrowing costs were 25 basis points below those of Italy today after declining to the least in two years yesterday. Investors had demanded higher yields to hold Spanish debt over Italian bonds from May 2010, as Italy was perceived as a less risky bet, until Aug. 5.

Widening Gap Seen

The spread may widen, said Harvinder Sian, a fixed-income strategist at Royal Bank of Scotland Group Plc in London. He said he has an “initial target” of 50 basis points for the gap, which he may extend “if Italy doesn’t do its homework.”

Zapatero’s constitutional budget measure, which follows moves to cut public wages, freeze pensions and axe a subsidy for new mothers, is undermining efforts by Socialist candidate Alfredo Perez Rubalcaba to hold his base and woo the so-called indignant ones who have organized demonstrations across the country since May.

Zapatero’s move to enshrine “the principle of budget discipline” in the constitution prompted protests by unions and a rebellion in the Socialist party. Antonio Gutierrez, a lawmaker and former union leader, said the measure was “political suicide.”

Protest Precedes Vote

Thousands of protesters marched in Madrid last night against the amendment, which the Senate approved in a final vote today.

The opposition PP would win 47.1 percent of the vote if elections were held now, compared with the Socialists’ 32.3 percent, giving it an outright majority in Parliament, according to a poll published by El Mundo on Sept. 4. That 14.8 percentage-point lead compares with a gap of 3.2 percentage points in November 2009, according to the newspaper.

“As a leftist, you have to talk about the welfare state in an election campaign,” said Ismael Crespo, head of political communication at the independent Fundacion Ortega-Maranon research institute in Madrid. “Zapatero is going to be erased from Socialist history. I think they’ll take down his photo at Socialist headquarters.”

Investors may remember him differently. Olaf Penninga, who helps manage 150 billion euros ($211 billion) at Robeco Group in Rotterdam, has moved back into Spanish bonds and prefers them to Italian debt, which the fund rates as “heavily underweight.”

“They have got their act together,” Penninga said in a telephone interview. “The Spanish response has been more credible and better managed. The government is communicating clearly and we don’t have this debate that we see in Italy between government members in public.”

Spanish Handicap

With a deficit of 9.2 percent of gross domestic product and growth slumping, Spain is far from out of trouble, as indicated by the extra yield demanded on Spanish debt over German bonds.

That spread narrowed to 310 basis points today, compared with the euro-era intraday high of 418 reached on Aug. 5 before the ECB started buying Spanish and Italian bonds. The spread between Italian and German 10-year debt was 335 basis points.

The minority Socialist government’s efforts may smooth the transition to a government led by Rajoy. While Rajoy, 56, says Spain needs more spending cuts and a deeper labor-market overhaul, his government will inherit the benefits of Zapatero’s changes to labor rules and spending plans that aim to slash the deficit by half in two years.

“The PP will not have to start from scratch,” said Moec of Deutsche Bank. “The groundwork has been laid.”

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