Spanish, Italian borrowing rates creep back up

A man tries to shelter under a copy of the Financial Times newspaper as he runs through a heavy rain shower outside the Bank of England in London, Wednesday, April 25, 2012. (AP / Matt Dunham)

MADRID -- A week after financial markets greeted European leaders' decision to help economically-troubled Spain and Italy, the two countries saw their borrowing rates rise again on Friday, signalling resurging concern over the sovereign debt crisis.

The rate, or yield, for the Spanish 10-year bond was up 0.22 percentage points to 6.96 per cent by early afternoon in Madrid. That level is deemed unsustainable over the long term and could push Spain to seek a full-blown bailout like Greece, Ireland and Portugal.

Italy's equivalent rate was up 0.13 percentage points to 6.01 per cent. In comparison, Germany's bond -- seen as a safe haven for investors -- was commanding a yield of just 1.37 per cent.

Both Spain's and Italy's yields fell sharply earlier this week in a wave of euphoria after European leaders agreed to channel aid directly to troubled banks, without further burdening a country's debt. They also agreed to make it easier for countries to get rescue loans and for the European bailout fund to buy bonds from other investors, which would lower countries' borrowing rates.

The summit decisions were generally seen as a step in the right direction in the resolution of the crisis, but the feeling is that more needs to be done -- and faster.

"The optimism following last week's EU leaders' summit is fading as concerns over various aspects of the agreement creep in," wrote Elisabeth Afseth and Brian Barry, fixed income analysts at Investec financial services, in a note to clients.

One key concern is that the European bailout fund will not be big enough if Spain or Italy needed rescue loans for their governments.

The bailout fund will have 500 million euros in lending power when the new, permanent version is finalized this month. It has already committed some C180 billion to help Greece, Ireland and Portugal. Spain will ask for as much as C100 billion to rescue its banks, and Cyprus is expected to seek a bailout of as much as C10 billion.

But European leaders have given no sign that they intend to increase the bailout fund's lending capacity. In fact, smaller eurozone countries like Finland have been complaining about the cost of the rescue operations.

The bond rates for Spain and Italy began inching up on Thursday, when the European Central Bank gave no indication that it would take more emergency action to ease eurozone government borrowing rates. The ECB has in the past bought the governments bonds of financially weak countries like Spain and Italy and also flooded banks with cheap loans. Those measures helped bring borrowing rates down, but only for a few months at a time.

Investors are also aware that the eurozone economy is in terrible shape, a fact which will make it more difficult for Spain and Italy to cut their public debt loads. Almost half the eurozone countries, including Spain and Italy, are in recession. Unemployment is at a euro-era record of 11.1 per cent across the currency bloc.

"Slowly the optimism after the last EU summit seems to be vanishing and reality is setting in with weak growth, high debt levels and unemployment once again in the spotlight," said Markus Huber, of ETX Capital financial services.

Beyond the economy, Spain's big problem is its banks, which are sitting on massive amounts of soured real estate investments.

The Spanish government last month finally recognized some of the banks were in deep trouble and its eurozone partners agreed to make available up to C100 billion in loans for the banks.

When that deal was announced, the existing rules were that the Spanish government would be responsible for repaying those loans. Fears that the government would not get the money back from banks and be hit with huge losses worried investors, who pushed the country's borrowing rates to euro-era highs above 7 per cent.

That is why the EU agreement to directly aid the banks, without adding to government debt, was seen as a victory for Madrid. However, the lack of detail on how and when the new rule will take effect seems to have punctured the balloon of optimism.

Eurozone finance ministers are expected to release some details on the bank bailout Monday.

"There is a feeling that the European Council meeting last Friday is not the `gamechanger' some had hoped for and funding pressures with regard to Spain and Italy are returning," said Neil MacKinnon of VTB Capital.