Spain under new pressure as borrowing costs rise

Government workers protest against austerity measures Government workers in Spain have been protesting against austerity measures again this week

Spain and Germany sought to reassure investors that Spain would not need a full international bailout, after its borrowing costs hit a record high.

German Finance Minister Wolfgang Schaeuble and his Spanish counterpart Luis de Guindos issued a statement.

They said Tuesday's record 7.6% yield on 10-year Spanish bonds - the government's implied borrowing costs - did not reflect economic fundamentals.

Mr Guindos will meet French Finance Minister Laurent Fabius on Wednesday.

'Worrying delay'

Spain's financial situation continues to worry investors, with borrowing costs rising and the Catalonia region saying it will need government funds.

On Tuesday, Spain claimed Italy and France back a plan for the immediate implementation of measures agreed last month.

These include aid directed at Spain's banks without adding to national debt.

Spain said there had been a "worrying delay" in executing the agreements thrashed out at the eurozone leaders summit on 29 June.

The main provision would be to allow the future European bailout fund, the ESM, to pour money directly into ailing banks such as those in in Spain, circumventing national governments.

The creation of the fund has been hampered by constitutional challenges in Germany which mean Berlin will not be able to ratify the agreement before 12 September.

"Speed is an essential condition for the success of any European action," the statement released by the Spanish foreign ministry said.

But, France's European Affairs Minister Bernard Cazeneuve denied any accord with Italy and Spain on immediate implementation.

"It makes no sense to say that. We are following the decisions taken at the European summit and are working on them," said Mr Cazeneuve.

The Italian government also categorically denied that it was part of any joint initiative with Spain.

Pressure

The record high yield on the Spanish government's benchmark 10-year bond reflects tension in the markets over the strain on its finances.

Rating agency Moody's warned Spain was more likely to need a full bailout, putting pressure on the euro's strongest economies, such as Germany.

Analysis

Higher borrowing costs can make the difference between a debt situation that is a problem and one that is ultimately unsustainable.

But the impact on the interest bill is slow, and that is why a spike in bond yields doesn't immediately wreck the Spanish government's finances. It's like turning an oil tanker.

When governments borrow they generally do it by selling bonds - which are a promise to repay - and the effective interest rate that the borrower has to pay is fixed for the lifetime of each batch of bonds.

Each time Spain goes to the market for new money, the interest rate it pays then feeds into its total borrowing costs. The general trend is upwards and that means the tanker is gradually turning towards the rocks. The eurozone has to decide whether to grab the wheel, giving a new bailout to keep those borrowing costs from rising further.

As a result, the agency changed its outlook for Germany's AAA credit rating to negative, the first step towards a possible downgrade within the next two years.

On Monday Spain's market regulator tried to make selling investments less easy.

It introduced a widespread ban on short-selling, a market technique whereby traders sell stock before they have to deliver it, in the expectation it will fall in price so they can buy it more cheaply in time to meet the order.

In other developments:

No options

Spain has already been granted a loan package of 100bn euros ($125bn; £80bn) for use by its banks, a different form of support than that given to the bailouts of Greece, the Republic of Ireland and Portugal.

But a number of the country's 17 autonomous regions are in deep debt and are lining up to tap a new 18bn-euro public fund.

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Ultimately the risks to Germany in becoming the eurozone's paymaster cannot be disguised”

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The request for help from Catalonia, the second-biggest, follows on the heels of a similar call for assistance from Valencia.

The region's finance minister told the BBC the region had "no other bank than the government of Spain".

Others are expected to join them in asking the central government for a handout at a time when it is having to pay more and more to borrow for its own financing needs.

Nicholas Spiro of Spiro Sovereign Strategies, said that it was a relief that Spain had raised all the funds it had wanted to at Tuesday's auction, but that the interest rate had spiralled: "The most important takeaway from this auction is that Spain was able get all its debt out the door.

"Still, in March, Spain was able to issue six-month debt at a yield of under 1%, now it is paying 3.7%."

Heavy burden

In addition to Germany, the Netherlands and Luxembourg - both AAA rated economies - were also put on negative watch late on Monday, joining France and Austria who were put in the same position earlier this year.

Moody's warned that Germany and other highly-rated countries may have to increase levels of support for countries such as Spain and Italy, who have not asked for a Greek-style bailout but who are struggling with high debt levels.

It said in a statement: "Even if such an event [a Greek exit] is avoided, there is an increasing likelihood that greater collective support for other euro area sovereigns, most notably Spain and Italy, will be required.

"This burden will likely fall most heavily on more highly rated member states if the euro area is to be preserved in its current form."

Moody's said there was an increased chance that Greece could leave the eurozone, which "would set off a chain of financial sector shocks".

It added that policymakers could only contain these shocks at a very high cost.

The German Finance Ministry said the country would remain strong, and said that Moody's was focusing on short-term risks.

Moody's is one of a handful of agencies that assess the creditworthiness of borrowers.

Rival agencies, including Standard & Poor's and Fitch, have Germany on the AAA top rating with a stable outlook, implying they do not currently foresee a weakening of its financial position, although all agencies regularly review their rankings.

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