Europe’s debt crisis has a habit of flaring during the summer months, and this year looks no different. In recent days, Spain’s ten-year spread over bunds has come within a whisker of its 22-year high, trading at over 600bps earlier this week. Its previous peak was 668bps, achieved on the 7th of October 1992 during the ERM crisis, soon after the Spanish central bank announced a 5% devaluation of the peseta against the Deutsche Mark. The devaluation was soon followed by an increase in the peseta’s permitted trading range against the Deutsche Mark to +/- 15%, rendering it essentially free-floating. Do current spreads indicate Spain may have to break away from a fixed exchange rate regime, as it did in the early 1990s? The answer to this question has profound implications. In our view; no single country can leave the euro. The financial contagion would overwhelm any potential firewall, causing the whole project to fall apart.

Investors are fearful of lending to Spain, at any maturity.

The toxic link between banks and sovereign has not yet been broken.

Public cuts and high unemployment have led to deteriorating fiscal position.

ECB to the rescue?

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