Germany and European Union officials are urgently exploring ways to rescue Spain's debt-stricken banks although Madrid has not yet requested assistance and is resisting political conditions, EU sources said on Wednesday.
Spain, the eurozone's fourth biggest economy, said on Tuesday it was effectively losing access to credit markets due to prohibitive borrowing costs and appealed to European partners to help revive its banks.
Economy Minister Luis de Guindos said after talks at the European Commission on Wednesday there were no immediate plans to apply for a bailout. Spain would await the results of an IMF report and an independent audit of the banking sector, both due this month, before taking decisions on how to recapitalize the banks, he said.
The European Central Bank dashed some market expectations of an easing of monetary policy, leaving interest rates on hold at 1 percent at its monthly meeting. That raises pressure on EU politicians to find a solution to the bloc's festering debt crisis at a summit later this month.
Sources familiar with discussions in Berlin and Brussels said intensive contingency planning was already under way for EU aid to Spain. Lawyers were examining the fine print of European treaties to see how Madrid could get money from the eurozone's rescue funds without the stigma of a full economic adjustment program, they said.
German officials said the aim was to avoid the embarrassment of Spain having to adopt new economic reforms imposed from outside and monitored by European and International Monetary Fund inspectors, as occurred with Greece, Portugal and Ireland.
In public, a German government spokesman repeated that it was up to Spain to decide whether to seek help from the eurozone's EFSF rescue fund.
European shares and the euro trimmed gains after the ECB decision to leave rates on hold despite a stagnant eurozone economy, which only just avoided a technical recession in the first quarter of this year.
A run of grim economic data and rising tension in financial markets over Spain's fragile banks and Greece's uncertain eurozone future had led markets to price in an outside chance that the ECB will lower rates.
Sources in Berlin said the German Finance Ministry believes the eurozone's permanent rescue fund, the 500-billion-euro ($625 billion) European Stability Mechanism, due to enter into force next month, could lend directly to Spain's FROB bank rescue fund. EU lawyers are not convinced this would be legal.
One advantage would be that smaller eurozone countries such as the Netherlands or Finland could not hold up a loan since approval by the ESM board does not require unanimity.
A series of reforms to Spain's financial system have failed to persuade investors that huge losses from a 2008 property market crash have been fully addressed, and doubts about the cost of a final rescue have deepened the eurozone debt crisis.
Finance chiefs of the Group of Seven major economies, afraid of a possible run on Spanish banks, held urgent but inconclusive talks on the European situation on Tuesday.
"The market's expectation regarding further policy action globally is picking up," said Ian Stannard, an executive director at Morgan Stanley.
Underlining the dangers to the entire 17-nation zone of inaction, Moody's Investors Service cut the credit ratings of several German and Austrian banks, citing the greater risk of further shocks stemming from the region's debt crisis. Germany is the single currency's strongest economy.
Spain is the latest member of the euro area under pressure to accept international aid following financial rescues of Greece, Ireland and Portugal in the two-year debt crisis.
The premium investors demand to hold its 10-year debt over the German equivalent hit a euro era high last week on concerns it will eventually have to accept a Greek-style bailout.
In the first public German pressure for Spain to apply for a bailout, the parliamentary floor leader of Chancellor Angela Merkel's conservatives said: "I think Spain needs to come under the rescue umbrella, not because of the country (the state budget) but because of its banks.
Volker Kauder, who is close to Merkel, told ARD television he did not believe Madrid could receive direct aid for its banks from the eurozone rescue fund and insisted that assistance to the state would entail the usual policy conditions.
"RUNNING OUT OF RUNWAY"
The U.S. Treasury, which chaired the G-7 phone hook-up, said in a statement that the group's finance chiefs had discussed "progress towards a financial and fiscal union in Europe" and agreed to monitor developments closely. But the group made no joint statement and took no immediate steps.
Japanese Finance Minister Jun Azumi added that major economies needed to ease market fears and referred to a G-20 meeting in Mexico on June 18-19.
The G-20 summit, to include both Japan and China, the world's top creditors, is shaping up as a key focus of global efforts to contain the eurozone crisis.
"We will cooperate and share responsibility to ease market worries through these meetings," Azumi told reporters.
The United States, which is pressuring European governments to take a bold step toward financial and fiscal union, would like to see the makings of a plan by the G-20 summit.
U.S. President Barack Obama, whose re-election chances this year could be jeopardized by another global financial crisis, has been anxious not to be seen dictating to Europe.
But Canadian Prime Minister Stephen Harper was more forthright on Tuesday: "I don't want to sound too alarmist, but we are kind of running out of runway here," he said.
EU leaders meet on June 28-29 to discuss a strategy for overcoming the crisis, which began in late 2009 when Greece revealed it had covered up a huge budget deficit.
"It doesn't look like they have a quick fix at hand, not a fundamental game changer at this point in time," said Rainer Guntermann, strategist at Commerzbank in Frankfurt.
Longer term, European leaders have begun thinking seriously about the economic union needed to secure the single currency. But that end-game is still months or years away.
SPAIN TO TEST MARKET
Spain will test the market on Thursday by issuing up to 2 billion euros ($2.5 billion) in government bonds at auction.
The ECB has so far shunned calls to resume purchases of Spanish government bonds, and Germany has rejected allowing direct aid from the eurozone's rescue fund to recapitalize Spanish banks without setting conditions for the government.
Pressure is building on Germany, the biggest contributor to eurozone rescue funds, to work harder on fostering growth.
Berlin argues it is already doing its share by encouraging generous domestic wage settlements, accepting the prospect of higher-than-usual German inflation and most recently agreeing that Spain should have more time to achieve its fiscal targets.
Chancellor Angela Merkel opened the door on Monday to the prospect of a eurozone banking union in the medium term, saying she would consider the idea of putting systemically important cross-border banks under European supervision.
However, Berlin is so far resisting a joint deposit guarantee for eurozone banks and a bank resolution fund, both of which would create new liabilities for German taxpayers.
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