Euro Extends Decline As ECB Rejected Spain's Bankia Plan

Euro broke below 1.25 against dollar after ECB rejected Spain's plan to recapitalize Bankia. The idea was for Spain's government to inject government bonds into Bankia, which then be used as collateral to get ECB funding. ECB urged that proper capital injection was needed and the plan was in danger of breaching the so called EU ban on "monetary financing," that is, violating the rules against central bank funding of governments. Also, Bank of Spain governor Miguel Angel Fernández Ordóñez announced to step down at the end of next week, a month earlier than planned on political pressure.

Meanwhile, Egan-Jones, a US rating agency, cut Spain's sovereign rating, for the 4th time since April, to B from BB-. The agency cited that Spain is expected to provided "substantial financial support" to banks over the next couple of quarters due to "declines in home values, austerity measures and increased unemployment." And, "Spain will inevitably be faced with payments to support a portion of its banking sector and for its weaker provinces." Assets of the two largest banks exceed Spain's GDP while those of the top five banks exceed 200% of GDP.

Also, ECB governing council member Nowotny said that the central bank is not considering to restart its bond purchase program. Nowotny said that ECB "has done a number of measures that were very helpful and efficient for the economy" and it's in a situation to see "how these measures have worked in the economy, especially in long-term operations." Regarding Greece, he said that the "prime objective" is to keep the country in the euro but that also depends on "decisions of Greek people and their government." Regarding Spain he said that “rescuing banks is the responsibility of national governments” and “the role of the ECB is in the field of liquidity, not solvency.”

Elsewhere, the Australia dollar is weighed down by disappointing retail sales figure, which showed -0.2% MoM fall in April. Japan manufacturing PMI was unchanged at 50.7 in May. New Zealand building permits dropped -7.2% MoM in April. Looking ahead, Spanish bond yields will be a major focus this week on whether it will march to the unsustainable 7% level. Greece political development will also be watched. Data to be released today include Swiss KOF, eurozone M3 and confidence indicators, UK mortgage approvals and M4, Canada IIPI and RMPI, and US pending home sales.