Clouds over Spain just got darker

While Spain's ruling PP is set to remain the largest party, it saw its support declined compared to the 2011 vote. The results do not leave a positive picture for government formation options. After tough negotiations and uncertainty, a grand coalition between the PP and PSOE is likely to be in the cards. Such a government would largely lead to a standstill in the reform process. The results will hit Spanish assets in the near term, and cloud the outlook for the Spanish economy longer out.

The temporary Spanish election results imply a hung parliament, which in itself is not a big surprise. However, the results also point to a very difficult government formation. From an ideological point of view, the most straightforward government formations would have been those between the ruling People's Party (PP) and the Ciudadanos (Cs) or between the Socialists (PSOE) and Podemos. However, neither of these combinations will be able to reach majority.

In fact, the results point to a grand coalition between the PP and the PSOE, which would have a comfortable majority in numbers. Nevertheless, as the two parties disagree heavily in the prescriptions for the future of Spain, forming such a government will not be easy, and other alternatives, including a minority government, will be examined carefully.

As a government between the PP and the PSOE would have very little common between them to stand on, it would most likely put a stop to the promising reform path Spain has been seeking for the past years. Unfortunately, the reform path is far from complete, so a stop to the reforms would darken the outlook for the Spanish economy considerably, especially longer out.

From reform perspective, the relatively weak performance of the Cs, the most reform-minded of the major parties, compared to the latest polls was disappointing. It suggests the importance of considerable changes to the structures of labour markets and the economy in general is either not given sufficient weight or not agreed with, which is a pity.

The decline in the popularity of the PP compared to the 2011 vote has a lot of reasons, not least the corruption scandals that have haunted the party. The results can thus not be interpreted as a strong vote-of-no-confidence towards the economic reforms the party has implemented. After all, the PSOE did much worse, so its policy prescriptions are not getting people excited either. The results thus say much more about the collapse of the two-party system in Spain than about specific policies the two main parties have been campaigning for.

"Economic policy is naturally not the only crucial area in the Euro area at the moment, as there are many other difficult issues at hand as well, like the migrant situation just to name one. In this situation, Europe is in dire need of common views and strong governments. It is thus bad news for Europe as a whole that the fourth largest Euro-area economy is not about to get one", says Nordea Bank.