As 1937 dawns in Spain, the now Allied Forces of King Xavier I launch a massive counterattack on Falangist forces in the North of Spain. Moving from Burgos and Madrid, spearheaded by French and British Volunteer divisions, and the Polish Jan Sobieski Legion, the Counter-Offensive takes Sanjurjo's forces in Castille and Leon off guard, as they had assumed it would take time for the Allied Forces to muster a combined campaign. Segovia would be retaken by March 11th. The German Condor Legion's Bf109 and Ju87 Planes mostly grounded in the winter fighting, allowing the British and Allied Spanish Troops to take the city without interference from the Condor Legion, which had withdrawn northwards to Leon in the face of the potential capture of that important transport hub by French and Allied Spanish Forces. The Majority of Sanjurjo's divisions were South of Leon trying to halt the Allied push from the South and if the French took Leon it would cut them off from retreat Northwards and potentially encircle the Vast Majority of Falangist forces. That could be the End of the Falangist Cause.
The Condor Legion was supported by 2 Divisions of Falangist Forces, but only one of those was a 1st Line Force, the 4th Infantry Division. The Other was a division of Garrison Troops, which were 3rd line divisions not really expected to see Combat. On March 4th the French and their Spanish Allies attacked Leon while the British, Polish, and Allied Spanish Forces were a week away from Victory in Segovia. The Fighting was Brutal, especially where the Condor Legion was concerned, but ultimately futile as the Forces arrayed against them were just too numerous and the French Volunteer Divisions too well equipped. The Condor Legion would Withdraw from Leon with a little over half of its Air Strength and a Third of its ground troops remaining. In exchange they had rendered 1 Allied Spanish Division and 1 Basque Division combat ineffective and had traded roughly even with 1 French Volunteer division. In addition, the Dive Bombing Tactics used by its pilots would delay the Allied Advance until the 17th of March, which allowed Several Falangist Divisions to slip around West of the City to withdraw North to Oveido before the route was cut. This allowed some 7 Battered Divisions to Defend Oveido from a determined assault. This number would not include the Condor Legion. Hitler, seeing the writing on the wall, evacuated the Legion on April 1st after a three day strategic bombing campaign concluded to tie down allied Forces and try to terrorize King Xavier's Government in Madrid into organizing a cease fire by bombing the Palace. It didn't work and on April 5th, the Condor Legion was evacuated from Spain via the Port of Gijon. Hitler would take note of what had worked in Spain and what didn't work and order his generals to fine tune their doctrine accordingly. As it had turned out German Doctrine was weak on the Defense.
The Battle For Oveido would last three weeks, from April 8th to April 29th. The fighting would be fierce and much of Oveido would be turned to Rubble, as unlike in Valencia, Madrid, and Burgos, the Defenders were numerous enough that the Allies did not mind just bombing and Shelling enemy hardpoints rather than going in to clear them room by room. Only Segovia would Rival Oveido in Destruction. As the pair of battles suffered by the city had ground it down. On the morning of the 28th of April, it was confirmed that General Sanjurjo had been killed in an Artillery Strike. The Defenders began to surrender en masse and by the 29th, there was nothing left of the Falangist Government of Spain aside from a few men fleeing to Germany via Gijon and prisoners.
On May 9th, 1937, King Xavier of Spain would proclaim that Spain had been unufied under the Banner of the Restored Kingdom of Spain. Elections for the Cortes, the Spanish Parliament would begin under the watchful eyes of France and Britain on the 4th of June.
Meanwhile, Hitler, Furious at Mussolini's quick withdrawal from Spain began to court the Hungarians as their primary ally. German technical assistance was given to the Hungarian Tank and Fighter Program in exchange for Hungarian Currency. This, combined with the millions of pre civil war Spanish Pesos, and Austrian Schillings allowed Germany to pad her foreign currency reserves. It helped that Schussenig had set the conversion rate between Reichsmarks and Austrian Schillings artificially high to allow Germany more wealth. This would allow the German Rearmament Program to build more tanks and planes.
Hungary meanwhile got more technical help in developing their own equipment, German Equipment as a stopgap, paid for by Hungary, and a Great Power ally backing her claims against Romania, Czechoslovakia, and Yugoslavia. They were coming up in the world.
When Mussolini heard about this, he began to ponder whether or not the Alliance with Germany was worth keeping. Italy couldn't ally with France without forgoing Claims on Nice and Corsica, but maybe Italy could be a Neutral Opportunist, never fully committing to any one alliance but opportunistically joining wars to Snag bits of Territory. Istria and Dalmatia were both owned by Yugoslavia and Hungary looked like it might attack that nation sooner or later. It might be worth sneaking in while the Yugoslavs were distracted to cut Croatia away for Italy.
Domestically in Germany, Hitler began the process of registering and ghettoing the Jews. This Pogrom was backed by SS and Gestapo troops and oftentimes the Jews were not allowed anything more than they could carry to bring to the new Ghettos on the outskirts of various cities, leaving much wealth to be seized by the Reich. The Pogrom was carried out throughout 1937, but it was only part of Hitler's plan. Hitler was a virulent anti-semite as were most of the Nazi elite. Wealth and Buisiness confiscation, registerring Jews and putting them into Ghettoes. All of this was Stage 1. Stage 2 was being drawn up in meetings throughout early1937 and would involve no less than the enslavement or extermination of all Jews in German territory. The camps were mostly built by october and the Jews began to be moved out of the Ghettos by the SS. By February of 1938, the Majority of German and Austrian Jews were in a forced labor camp or dead.
Then Hitler could move onto other issues, like the Sudetenland. . .