Focus on southern Europe – Spain’s crisis psychological as well as real, says Morgan Stanley

Morgan Stanley has turned to behavioural psychology to explain, in part, investors’ panic about Spanish bond markets in recent days, saying the “psychology of contagion” as much as the country’s real economic woes lie behind reactions.

Spain’s long-term borrowing costs have exceeded 7.5% in recent days, and Madrid earlier this week banned some short selling, in an effort to relieve market pressure.

Morgan Stanley warned today that current investor concerns about the crisis situation for Spain’s bond market – among several others – have been exaccerbated over recent days as much by a behavioural reaction among investors as events in the real world.

In the report titled Spain and the psychology of contagion economists at the US bank said:  “There’s nothing ‘special’ about Spain’s economic and fiscal problems. To be sure, they are substantial, and we expect Spanish GDP to shrink in excess of 2% this year and 1% next, making it difficult for the government to reach its fiscal targets.

“We think that the main mechanism at play here is behavioural in nature.”

When one Eurozone sovereign refers to external support mechanism, investors naturally focus on the next weak link.

“This is how contagion has propagated from the small peripherals to the large southern European countries, and the way for contagion spreading further,” the research added.

Morgan Stanley said provision of official funding for Madrid would certainly be positive, not least compared to an alternative where Spain might be unable to fund, but it added it was concerned “such positive reaction might be short-lived”.

In other words, without moves towards fuller fiscal integration, intervention in Spanish bond markets would provide only temporary respite from sovereign market stresses.

Investors have three main concerns, according to the US bank. These are completeness, sequencing, and execution.

Despite progress on banking integration, a lack of progress on fiscal integration – both in terms of strict budget controls at the European level and by debt mutualisation – might have left market participants with the impression “many risks remain before a truly coherent plan for a more federal Europe finally materialises,” the research warned.

Moreover, there has been progress and commitments to further banking integration, but no near-term mechanism to ease sovereign funding pressures have been announced.

Finally, on execution, Morgan Stanley said even if recent summits seemed to have delivered commitment to integrate further, the actual implementation of some of the decisions is proving more difficult.

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