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Spanish stocks hit their lowest levels in almost three months and government bond yields rose sharply on Monday, after the most inconclusive election in Spain's history pointed to weeks of difficult coalition talks. Prime Minister Mariano Rajoy's centre-right People's Party (PP) gained the most votes in Sunday's poll but fell well short of a majority, while left-wing parties also failed to win a clear mandate to govern, casting a pall over economic reforms that have helped pull Spain out of recession.
"It all looks a bit more uncertain than we were hoping," said Capital Economics chief European economist Jonathan Loynes. "The good news is that Spain's economy is in pretty good shape but the longer the political uncertainty drags on, the greater it will impact market sentiment and, more importantly, business and consumer sentiment."
Before the vote, investors had worried an unclear result could delay necessary reforms and revive concerns about Spain's fragile finances. Its public debt is around 100 percent of GDP, compared with 92.5 percent for the euro zone as a whole. Spain's IBEX stock index was down 3.6 percent to 9,365.8 points, its lowest since late September. Spanish banks BBVA and Santander, down 4.7 and 4.8 percent respectively, were the day's worst performers on the Euro STOXX 50 index of euro zone bluechips. Spanish power generator Iberdrola and telecoms company Telefonica were also among the biggest fallers, down 2.3 and 3.4 percent.
The yield gap between Spanish and German 10-year bonds touched 130 basis points, its widest in a month, as investors reacted to the uncertainty. Spanish 10- and 30-year yields hit their highest levels in over a month, with 10-year yields briefly rising more than 10 bps to 1.89 percent, compared with a 2 bps rise in Italian equivalents and a marginal fall in German borrowing costs. The euro was up slightly at $1.0929. However, Spanish bond yields remain a fraction of levels hit at the height of the euro zone debt crisis in 2012, when 10-year borrowing costs topped 7 percent.
Spain has been a big beneficiary of the European Central Bank's bond-buying stimulus programme, which drove 10-year yields to record lows just below 1 percent in March and remains a major source of support. The likelihood of a PP-led coalition faded with the robust showing of populist party Podemos, which roared into third place and outpaced fellow newcomer Ciudadanos ('Citizens'), whose market-friendly policies had been seen as a natural fit for a coalition with PP.
A tie-up between the PP and Ciudadanos would return 163 seats, far short of the 176 needed for a majority. However, forging a left-wing alliance will also be tough. Five left-wing parties led by the opposition Socialists and Podemos together won 172 seats but they differ on economic policy and autonomy for the region of Catalonia.
With the PP and Socialists having dominated Spanish politics since the 1970s, analysts say a lack of experience in coalition building could see the process drag on for weeks or months. "With parliament in recess until around mid-January probably, we do not expect a vote of investiture to be presented before late January," Societe Generale said. The election outcome parallels neighbouring Portugal, where the incumbent conservatives won the most votes in October but a socialist government backed by far-left parties was ultimately sworn in.

Copyright Reuters, 2015

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