Spanish Borrowing Costs Surge, Reviving Worries About Euro Zone

Spanish Borrowing Costs Surge, Reviving Worries About Euro Zone

By STEPHEN CASTLE
Published: July 19, 2012
LONDON — The Spanish government had to pay more to sell its medium-term debt Thursday, while yields on its 10-year bonds crept above the symbolically important 7 percent threshold — a worrying development for the euro zone, which had hoped that recent accords would help put a two-year-old sovereign debt crisis behind it.
Spain’s Treasury sold 2.96 billion euros, or $3.6 billion, in bonds maturing in 2014, 2017 and 2019. The interest rate on the five-year debt rose sharply to 6.46 percent, from 5.54 percent at the last such auction on July 5. There were no comparable rates for the other maturities.

Yields on 10-year Spanish government bonds rose to 7.03 percent. Many analysts believe that such
rates would make Spain’s finances unsustainable in the medium term.

“Demand for Spanish paper is collapsing, even for shorter-dated debt, which is very worrying and raises the specter of Spain losing market access,” said Nicolas Spiro, managing director of Spiro Sovereign Strategy, a London-based consulting firm specializing in sovereign credit risk.

“The yield levels, particularly for the 5- and 7-year bonds, are prohibitive and reflect the deep skepticism about the Spanish economy’s ability to get out of the rut in which it finds itself,” Mr. Spiro said.

The Spanish Parliament is due to vote Thursday on the latest round of spending cuts proposed by the government of Prime Minister Mariano Rajoy. Labor unions have called for demonstrations across the country to protest the cuts.

And in another crucial vote for Spain on Thursday, German lawmakers in Berlin are expected to approve their country’s portion of Europe’s bailout package for Spanish banks. But the margin of that vote will be closely for signs of increased opposition to euro zone bailouts from Germany, Europe’s biggest economy.

Spain’s borrowing costs had fallen back briefly following a deal among leaders of the 17-nation euro area at the end of June that enabled the Spanish bailout. But costs have been inching up since, partly because of worries about the detail of Spain’s bank bailout.

Mr. Spiro said that Spanish borrowing costs were now moving back up to where they were before the summit.

“Sentiment-wise, we’re pretty much back to Square One as far as Spain is concerned,” he said.

“This is no longer about the Rajoy government bungling its reforms. This is about a crisis of confidence in euro zone policymaking.”

In German, although the chancellor, Angela Merkel, was widely expected to win approval for the Spain bank bailout with the support of many political opponents, some members of her own center-right-led coalition could rebel because of worries about the risks to Germany of such steps.

Because of its size and importance in the euro area, Germany is expected to guarantee about 30 percent of the total aid package of up to 100 billion euros, which aims to salvage a Spanish banking sector brought close to collapse by a drastic property slump.

Under the agreement made at by E.U. leaders in late June, the aid could go directly to the Spanish banking sector — something welcomed by the financial markets, which fear that, otherwise, the rescue would simply worsen Span’s battle to reduce its debt burden.

Germany insists, however, that direct recapitalization of banks can only take place once a new European banking regulatory system has been put in place, at which point the debt could be transferred from the Spanish government’s books.

Yet even with that caveat, some of Ms. Merkel’s conservative parliamentarians and her coalition allies from the Free Democrats believe she has given too much ground in allowing the euro zone bailout funds more flexibility to recapitalize banks directly.

Meanwhile, there are worries that a full rescue for Spain’s government might be needed if its borrowing costs remain at current, elevated, levels.

A significant parliamentary rebellion would send a strong warning to Ms. Merkel over policy toward the euro zone. And though she needs only a simple majority to get the law through, having to rely on opposition votes — and losing her so-called chancellor’s majority — would be a political setback for her.

Ms. Merkel’s room to maneuver is also constrained by Germany’s Constitutional Court, which has delayed the entry into force of the euro zone’s permanent bailout fund, the European Stability Mechanism, pending a review of whether it is in line with Germany’s constitution. The E.S.M. was due to come into operation this month but the court has said it will not deliver its verdict until Sept. 12.

On Friday euro zone finance ministers are due to hold talks by videoconference to agree on the release of 30 billion euros of the Spanish bank rescue.

In Rome, meanwhile, the lower house of the Italian Parliament ratified the fiscal compact, the treaty that requires European governments to control their finances.

At midday in Europe the Euro Stoxx 50, a measure of euro zone blue chips, was up 0.86 percent. The FTSE 100-share index in London was up 0.36 percent.

Asian stocks were higher, with the Nikkei 225-share index up 0.79 percent and the Hang Seng index in Hong Kong up 1.66 percent.

The euro was at $1.2305, up from $1.2260 late Wednesday in New York.