The euro zone was under a lot of pressure to provide some clarity ahead of the Greek elections this week.
But Sebastian says instead of providing clarity, the Spanish bailout has just created more uncertainty.
“There was a lot of hope that we would get a strong bailout package with clear shift in providing certainty and putting a backstop to what is taking place in Europe. That did not take place and the big question is what is left and will you see a shift in focus now to what is happening in Italy,” he says.
“The problem is moving from the peripheral economies to the major economies in Europe and the contagion effect is key. It has been slowly rumbling to a point and this week will be a defining moment, given the Greek elections this week.”
News of the bailout was greeted positively by markets with Asian equities traded higher across the board and Hong Kong’s Hang Seng leading with gains of 2%.
Commodity prices also benefitted from the risk rally with oil up 2.2%.
Spanish borrowing costs on 10-year bonds spiked by 25 basis points, which Sebastian says is a “clear indicator” to markets that this is not the end all and be all, and we are not through this by any means.
“The Australian markets didn’t get a chance to react positively to the data because they were closed for the public holidays, but nonetheless I think markets will take a turn to the weaker,” he says.
“Falls today will be somewhat subdued, as we were closed yesterday so we did not have that sharp rally. The risks are there that the level of risk aversion remains and the currency has come back from hitting parity yesterday.”
The Australian dollar rallied to four-week highs against the US dollar on Monday and jumped to $1.0010 in early trade, rallying nearly a full US cent to hit its highest level since mid-May.
The direct impact of Spain’s economies in Australia is very difficult to determine, but economists warn that Australia could feel the ripples from Europe via Asia.
“Clearly Australia is tied into the global growth story, so there’s the risk of a downward leg in Europe that is also a risk in Australia,” says Paul Bloxham, chief economist at HSBC.
“You can certainly say it is another step in the challenging environment that Europe faces at the moment. There is concern about the Spanish banking system and the Italian debt situation and the Greek election this weekend: all of these things are important for the outlook of the sustainability of the euro and that gives financial markets jitters across the world.
“The main channel through which this influences Australia is impact on Asian growth, as Asia is highly exposed to Europe as a major trading partner and a finance system funded by Asia, so that has an indirect impact on Asia’s trading partners.”
While the Australian banking system is less dependent on Europe than it was in 2009, it still requires overseas wholesale money for about 30% to 40% of its funding and Europe is a major source of this funding.
Sebastian says the impact is likely to be felt in borrowing costs and reduced confidence in Australia.
“I think the impact is more from a financial sense than anything else. It can have a serious impact on borrowing costs for Australian financial institutions and we have seen a spike in those in recent times,” he says.
“It is not a structural issue for Australia but more a confidence issue. The Reserve Bank has taken out added insurance to instil confidence but that can be fast eroded by what is taking place in Europe.”
The answer, unfortunately, is yes.
“When a banking system needs bailing out it confirms that conditions are weak worldwide,” says Bloxham.
Despite the strong economic figures published last week, Bloxham warns Australia is still at risk.
“The concern is that it will stunt Asian growth and indirectly impact on Australia’s economic situation,” he says.
Cara Waters is a former SmartCompany editor. Previously, Cara was a senior reporter for the Financial Times’ website and worked for The Sunday Times in London.
