Spain borrowing costs soar in debt auction

Spain paid sharply higher interest rates in a short-term bill auction on Tuesday, highlighting growing investor concerns that the country might eventually need foreign help to finance itself.

The Treasury raised (EURO)3.39 billion ($4.28 billion) in 12- and 18-month bills _ more than its upper target of (EURO)3 billion _ and demand was robust, but the cost skyrocketed. The interest rate on the 12-month bills rose to 5.07 percent from 2.98 percent at the last such auction on May 14. The rate on the 18-month bills soared to 5.10 percent from 3.3 percent.

In the secondary market, where issued debt is traded openly, the yield on 10-year Spanish bonds remained perilously high at 7.03 percent, down 0.10 percentage points from the previous day.

Worries about Spain's ability to repay its debt grew last week when the country agreed to accept a eurozone loan of up to (EURO)100 billion to shore up its ailing banks, which are sitting on massive amounts of soured real estate investments.

The big fear is that, as the money will count as a loan and raise Spain's overall debt load, the country's financing costs will suffocate the government as it tries to wade its way through a money-sucking recession and a 24.4 percent jobless rate.

Marc Ostwald of Monument Securities said that while Spain met its sale target for the debt auction on Tuesday, "the yields at which these were sold can only be described as prohibitively expensive."

If investors are demanding such high rates for short-term debt, Spain needs not only a eurozone rescue package for its banks but "an outright bail-out package," Ostwald said. "It is becoming very difficult to see how it can manage without that beyond the end of the third quarter, unless yields fall dramatically!"

Markets were also rattled ahead of the auction by news that the second part of a government-ordered audit of Spanish banks has been delayed to September from late July. A separate, less thorough stress test by two companies remains due to be delivered this week, but when it will be made public is not clear.

Spain can survive the current high interest rates for weeks or even months, analysts say, but not in the longer term. If it becomes clear that the borrowing rates will not come back down, Spain will likely have to ask for a European bailout _ money that would come at lower interest rates than those offered by bond markets. The problem is that Spain's (EURO)1.1 trillion economy is the eurozone's fourth-biggest and larger than those of bailed-out Greece, Ireland and Portugal combined.

The Spanish economy minister, attending the Group of 20 world leaders' summit in Mexico, said the country is being punished unfairly in debt markets.

"We in the government are convinced that the current situation of punishment in the markets, what we're suffering from today, doesn't correspond with the efforts, or the potential, of the Spanish economy," Luis de Guindos said Monday. "This is something that will have to be recognized in the coming days and weeks."

Spain is waiting for the two independent audits of its banks, due to be presented to the government Thursday, to determine how much of the (EURO)100 billion eurozone rescue loans Spain will tap. Investor sentiment toward Spain will in coming days depend upon the sum of loans demanded as well as any support measures announced by European leaders.

A draft of the G-20 final statement says the world's largest economies in the developed and developing world want to stress economic growth as a way to end Europe's crisis. That stands in contrast to the current German-driven austerity drive to bring deficits down.

Analysts again seem underwhelmed by European leaders' response to the crisis.

Michael Hewson, senior market analyst at CMC Markets UK, said the rise in the Spanish 10-year bond rate this week "once again puts Europe's fourth largest economy squarely in the cross hairs as the probable next candidate for a bailout."

"Fears about growing bad debts and deposit outflows from Spanish banks have proved a toxic combination as European leaders dither on what the next steps in the crisis should be."

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