Spain is going to the polls on 29 November. Pedro Sánchez dissolved parliament on Monday, three days after Congress voted down his government's housing decrees. Investors hardly noticed. The sharper story in European markets this week sits north of the Pyrenees.
The housing decrees would have extended a rent freeze, restricted short-term lets and banned evictions of vulnerable tenants until 2030. Sánchez's minority coalition holds 147 of the 350 seats, and the Catalan party Junts, a frequent partner, joined the opposition to kill them. Protesters outside parliament chanted that they were being sacrificed for landlords' profits.
In his statement, Sánchez said Spain needs "a much broader, progressive majority" to finish its reforms, and pointed to a country that is, in his words, the fastest-growing economy in the EU. Without a majority for next year's budget either, an early vote was the cleaner exit. Markets had priced it in since late last week.
On Thursday 1 October something snapped in the euro area's bond markets. French bonds, already under pressure, fell again, and Italian, Belgian and Greek bonds went down with them. The yield gap between French and German 10-year bonds is now the widest since the euro-area debt crisis of 2011-12. France is running a deficit above 5% of GDP, its government presented a 2027 budget on 1 October aiming for 5.0%, and investors doubt that a minority government can last long enough to deliver it before the presidential election next year.
The worry has now spread to currencies. The euro slid to its weakest level against the dollar in 17 months on Monday, around $1.12. "We are starting to see first signs of contagion," Jeff Mueller of Morgan Stanley Investment Management said. European equities are feeling it too: the Stoxx Europe 600 fell 1.1% last week, its fourth weekly decline in five.
The obvious question is whether the European Central Bank steps in. It has a tool for exactly this kind of moment, the Transmission Protection Instrument, created in 2022 during an Italian bond selloff. It has never been used.
The catch is in the design. The TPI is meant for "unwarranted" market moves, and eligible countries must be pursuing sound and sustainable policies. France, in an excessive-deficit procedure with a 2026 shortfall well above the EU's 3% limit, is a hard case to argue as unwarranted. Using the tool anyway would risk its credibility. Bundesbank and ECB officials have said as much in public.
Inflation makes it harder still. Eurozone consumer prices rose 3.8% in September, a three-year high and above the 3.6% economists expected, with energy driving most of the jump. Core inflation, which strips out food and energy, rose to 2.5%. The ECB has raised rates twice this year, in June and September, and its next meeting is on 29 October. A central bank worried about prices cannot easily loosen policy to calm bond markets.
There is a succession subplot as well. The two leading candidates to replace Christine Lagarde, Pablo Hernández de Cos of Spain and Klaas Knot of the Netherlands, are due to meet Chancellor Friedrich Merz.
Spain's election matters for Madrid's budget and its housing policy, but it is not what is driving the euro. The market is asking a different question: whether the euro area's second-largest economy can pass a credible budget in a political crisis, with a central bank that has no easy way to help.
Governments elsewhere are already asking for more room. Italy and Greece have requested flexibility under the EU deficit rules because of fuel costs, a request that sits oddly beside the pressure on Paris. What to watch next: how French spreads behave after the budget debate begins, any rating action on France, and whether the ECB signals anything on 29 October beyond rates.
