THE high is over. The European Central Bank's two long-term refinancing operations (LTROs) in December and February saw commercial banks borrow over €1 trillion ($1.3 trillion) of three-year money at the ECB's main interest rate, which it had cut to 1%. Ostensibly a scheme to keep euro-area banks afloat, the LTROs also boosted flagging public-debt markets in the zone's southern periphery, as banks used some of the cash to buy high-yielding bonds. That effect has faded.





Yet Spain has deeper problems than muddled messages. The 2011 budget deficit was 8.5% of GDP, not the goal of 6%, in large part because of overspending by Spain's autonomous regions. The economy is in recession—industry shrank by 5.1% in the year to February according to figures released on April 11th. Attempts to cut the deficit by 3.2% of GDP in a year will make things worse. Reforms to the jobs market, making it cheaper to fire workers and easier to set pay locally, will benefit Spain's economy in time but not now.

Anxiety about Spain's banks worsens the outlook further. A messy end to Spain's long construction and mortgage boom means a lot of bank loans have already turned sour. More are likely to. Property prices have not yet fallen as far as in Ireland, the euro zone's other housing black spot. Investors fear that the state will be called on to recapitalise Spain's banks.

To complicate matters, much of Spain's huge private debt is owed indirectly to foreigners via its banks. Spain's net investment deficit—the sums owed to foreigners by firms, householders and the government, less the foreign assets they own—comes to 93% of GDP, the cumulation of a long series of current-account deficits. The increasing home bias of euro-zone investors makes it harder for countries with foreign debts to roll them over. Greece and Portugal have similar foreign debts but have higher borrowing costs (see chart 2).

Spain and Italy could not live with today's borrowing costs for long unless the outlook for their economies were to improve dramatically. So they may have to look to outside help. But it would be hard for the ECB to sanction another LTRO so soon, reckons Laurence Boone of Bank of America. The ECB could restart direct bond purchases: Benoît Cœuré, a member of the bank's six-strong executive board, suggested on April 11th that it might, which helped push Spain's bond yields down a bit. But that would make existing investors worry more about subordination to the ECB in the event of a restructuring. In any case Mario Draghi, the bank's president, has recently said high yields are the bond markets' way of asking governments to implement promised reforms.
