Job market improves as Moody's threatens downgrade

Moody's Investors Service on Friday threatened to downgrade Spain's sovereign rating, citing funding cost pressure due to the doubts sown by the second Greek bailout package, weak economic growth and concerns about the state of the regions' finances.

Moody's announcement coincided with the latest employment figure that showed a slight drop in the jobless rate in the second quarter, but with over a fifth of the working population still out of work. Inflation in July also remained above 3 percent despite weak domestic demand.

Moody's said its review of Spain's Aa2 rating is likely to lead at most to a downgrade of one notch. The threat, however, was sufficient to drive Spain's risk premium higher and push down the share prices of leading banks, such as Santander and BBVA, the ratings of which are also under scrutiny by Moody's, along with those of the regions of Castilla-La Mancha, Murcia, Valencia, Catalonia, Andalusia and Castilla y Léon.

"Regional governments' finances may prove difficult to control due to structural spending pressures, particularly in the healthcare sector," Moody's said in a release.

"This news is a blow to Europe's efforts to contain the debt crisis to smaller countries like Greece or Portugal," Bloomberg said, quoting Kornelius Purps, a fixed-income strategist at UniCredit in Munich.

Moody's said the precedent set by the Greek deal opens the door for private participation in future support for euro-zone members. It also highlighted the uncertainty about the size and scope of action of the emergency European Financial Stability Fund (EFSF).

The concerns have already had a negative impact on Spanish financial assets, and are expected to continue to do so in the immediate future.

"The trigger is that the [Greek] deal last week has not really built confidence across the euro zone so Spain is still on the radar screen with costs rising," Reuters quoted Citi analyst Giada Giani as saying.

In a note, the Spanish Treasury described Moody's concerns as "misplaced" given Spain's low debt/GDP ratio and the government's commitment to fiscal consolidation and structural reforms.

"The government will continue to show the breadth and impact of the structural reforms in the financial, labor and product markets," the Treasury said.

Moody's also highlighted the financial situation of the regions, which has been another source of political conflict with the central government. "Challenges to long-term budget balance remain due to Spain's subdued economic growth and fiscal slippage within parts of its regional and local government sector," Moody's said.

In an interview with Spanish radio station Onda Cero, Spain's Economy Minister Elena Salgado attributed Moody's review to the "noise" generated by a number of regions now controlled by the Popular Party, which have complained bitterly about the state of the regional finances left by outgoing Socialist administrations.

"The noise of the past few days hasn't helped either because it seems to indicate in the eyes of Moody's that some regions will have difficulties in meeting the deficit target," said Salgado.

Despite that "noise," at a meeting earlier this week with Salgado, the regions agreed to trim their budget deficit to 1.3 percent of GDP next year and 1.1 percent in 2013. They also pledged to introduce regional legislation on spending caps.

Meanwhile, unemployment, the major concern of most Spaniards, eased somewhat in the second quarter of the year, but still remained at disturbingly high levels.

According to the National Statistics Institute's (INE) latest quarterly Active Population Survey (EPA), the jobless rate in the period April-June fell to 20.9 percent from 21.3 percent in the previous three months as the number of people out of work dropped by 76,500 to 4.833 million.

The job market in part was helped by increased hiring ahead of the major holiday period. Employment in the third quarter rose by 151,400, but at the same time the active population increased by 74,900 to 23.136 million.

In remarks to Onda Cero, Economy Minister Elena Salgado said the period April-June was the first quarter of "clear" job creation since 2007, a factor that pointed to a "change in trend."

Along the same lines, Prime Minister José Luis Rodríguez Zapatero said while unemployment remained "unacceptably very high," there were "encouraging" signs in the EPA.

The slight improvement in the labor market was driven by the services sector and to a lesser extent industry, while construction and agriculture continued to shed jobs.

As well as the jobless woes, Spaniards are also having to cope with a loss of purchasing power due to persistently high inflation, which according to INE fell to 3.1 percent in July from 3.2 percent in June.

Meanwhile, the International Monetary Fund report released Friday urged the government to introduce more measures to rein in the public deficit and push ahead with reforms to the labor market.