ForexSpace.com - Markets may well have been breathing a welcome sigh of relief over their cornflakes this morning, as the European Central Bank announced plans to place a rather conspicuous plaster over Bankia’s gaping wounds. A cash injection from the ECB could absolve bond investors of having to bear the brunt of any cost – a move which could hurt prospects for any lowly investor.

But as Simon Denham, MD of Capital Spreads wrote in an emailed note this morning: “This unorthodox attempt to place a firewall around Bankia is another sticky plaster that Europe has been putting on the wounds for the last few years in order to stop the haemorrhaging, and for now investors seem to like the idea.”  The problem, he identified, is the precedent that this sort of behaviour sets moving forward. With the ECB forecasting economic contraction for the euro zone in the coming Q, the prospect for many beleaguered banks – of which Bankia is one - is far from rosy. “The rule book is being well and truly ignored in a bid to save the euro zone from collapse but meanwhile many are preparing themselves for what they believe to be an inevitable breakup of the single currency”, Denham added.

More credit risk

Instead of pumping more and more cash into Bankia, Spain is now proposing to hand the lender government bonds. The hope being that Bankia will be able to use that debt as collateral for a loan from the ECB. But with so much uncertainty over the economic future of the nation and the region-at-large, some top analysts are concerned that certain currency bloc members will be less-than-impressed about the prospect of further risk. “I’m not sure that the ECB’s northern European membership will be very happy about the central bank taking on that credit risk,” said Paul Smillie, a credit analyst at Threadneedle Asset Management Ltd. in London, which oversees about $43 billion of fixed-income assets. “I’m not sure how workable the idea is.”

In a desperate bid to avoid the scenario depicted by today’s ForexSapce cartoon, yesterday saw four of Greece’s biggest banks handed over 18bn euros in a bid to boost the capital reserves of National Bank, Alpha, Eurobank and Piraeus Bank and avoid any bank run scenarios. The money came from the European Financial Stability Facility rescue fund and provides an example of yet another way that the euro zone nations are managing to keep their financial systems afloat in unique ways amid the turmoil.

The small rally seen this morning as traders and forex brokers await a decision from the ECB sent the European indices are back at the highs they resisted yesterday. For now, bulls appear to be satiated by the proposed deal alone, with Spanish 10 year bond yields remaining around the previously set 6.5 percent mark.

The big problem

"The biggest problem here is that the ECB could object. That's a legal issue, but technically it is possible," said Jose Carlos Diez, economist at Intermoney Valores. So far – despite meeting initial investor nerves yesterday when the plan was announced and Bankia shares plunged 14.3 percent – the idea for a taxpayer-funded “bailout” has been well met by the markets.

Despite the largely positive response from investors this morning - EUR/USD hit a high around 1.2625 helped no doubt by the fact that positioning was at record short levels –the intensification of Spanish banking concerns and a Spanish debt sell-off have left the EUR vulnerable to a drop below 1.2500 on live forex charts.

Sarah Cox, Staff Writer