Spanish and Italian bond yields rise, as France backs fiscal integration in the euro zone.

Tuesday 12 June 2012 18.51
The cost of borrowing for the Spanish and Italian governments is at unsustainable levels
The cost of borrowing for the Spanish and Italian governments is at unsustainable levels

The interest rate on 10-year Spanish bonds set a record of 6.795% today.

This is the highest level since the euro zone was founded despite approval of a massive bailout for Spanish banks.

"The situation in Spain is worse than last week," said a sovereign debt market trader who estimated that a €100 billion plan for Spanish banks would not calm investors fears.

The cost of borrowing for Italy has also risen, reaching 6.2% this afternoon.

Far from calming the markets, the rescue for Spain exposed a string of new doubts over the impact on the debt; how it will be implemented; and whether it will be just the first rescue for a nation struggling to cut deficits in a period of recession and sky-high unemployment.

In Ireland's case, the interest rate on Government bonds is academic because the Government borrows from the EU and IMF.

However in the case of Spain it is supposed to continue to finance its budget deficit by borrowing from the markets. If the country's cost of borrowing continues to escalate it would not be able to do that.

At this stage the only way to keep a lid on the unfolding drama would be for the European Central Bank to intervene and buy Spanish bonds in large quantities.

Spain was expected formally to seek the loan at a euro zone finance ministers' meeting June 21, and a final figure would come after a review by the European Union, European Central Bank and IMF, officials said.

Spanish debt could peak at 95% of GDP

A report by Barclays Capital analysts said that a loan of €70-80 billion euros would push up Spain's public debt by 7.0%-7.5% percentage points from the end-2011 level of 68.5% percent of economic output.

Under this scenario, Spanish public debt would likely peak at 95% of economic output by 2015, they predicted.

Several analysts warned that a Spanish banking rescue using the ESM, which comes into force next month, could have the unintended effect of scaring ordinary investors away from Spanish government bonds.

"If the amount borrowed from the ESM were to materially exceed the currently expected 100 million euros, the ESM's self-declared preferred creditor status could, in our view, constrain Spain's access to the capital markets and therefore reduce the likelihood of bond holders being paid in full," said Standard & Poor's rating agency.

In Brussels, the European Union's Economic Affairs chief, Olli Rehn, said the euro zone would decide rapidly which of the bailout funds it would tap for Spain's line of credit.

Tiny Cyprus added to the gloom. The country's Finance Minister Vassos Shiarly said last night that his country had an "exceptionally urgent" need for a bailout to recapitalise its banks by June 30, according to the Wall Street Journal.

The island's economy is only a 60th of the size of Spain's, it said.

All eyes turn to Greece

Greece has paid a moderately higher yield, 4.73% on a sale of six month bonds, ahead of next Sunday's crucial election. The yield, the rate of return earned by investors, is up from 4.69% on May 8.

Greece goes back to the polls on Sunday, following an inconclusive election on May 6 that failed to give any party a majority or allow the formation of a coalition.

Greek voters are angry at two years of austerity measures, part of two EU-IMF bailout packages that have included steep salary and pension cuts as well as higher taxes.

The two main contestants are the conservative New Democracy party that has pledged to renegotiate some of the loan deal's terms and the radical left Syriza party that has vowed to reject the agreement altogether.

If Greece's creditors refuse to cut it more slack, the flow of aid will cease and the government could within weeks run out of money, potentially meaning that it leaves the euro zone.

The Greek Public Debt Management Agency raised €1.625 billion in today's sale.

Total bids in the debt auction reached €2.669 billion and the amount finally accepted was €1.625 billion euros, according to the agency.

This was the first auction to be carried out after the departure of the agency's director general Petros Christodoulou, who recently moved to Greece's premier private bank, the National Bank of Greece (NBG).