Spain and France lead falls in borrowing costs

SPAIN AND France led falls in euro zone borrowing costs yesterday after bond auctions drew better-than-expected investor demand ahead of what was being billed as a “landmark” speech by French president Nicolas Sarkozy last night.

The euro also strengthened ahead of the speech in which Mr Sarkozy proposed a new treaty to “refound” Europe. It was the fourth successive day of gains for the single currency and came after comments from European Central Bank president Mario Draghi which signalled the bank may take stronger crisis action if governments push the euro area towards a fiscal union.

Italian borrowing costs also fell below 7 per cent for the first time in a week as markets anticipated choreographed statements on greater fiscal union from Mr Draghi, Mr Sarkozy and German chancellor Angela Merkel today.

Mr Draghi highlighted the euro zone’s fragile outlook, saying downside risks to the economy had increased and the bank’s temporary measures were limited.

This reinforced a market view that the ECB could cut interest rates and extend its liquidity measures when it meets to decide on monetary policy next week.

Stock markets retreated yesterday after surging on Wednesday on the back of a co-ordinated move by six central banks to reduce financing costs to banks.

Spain succeeded in selling €3.75 billion of bonds – though it had to pay the most since at least 2005 to borrow for five years – with investors ordering twice the amount sold. Spain changed the securities it planned to sell at the auction, opting for longer-dated notes that already trade instead of a new benchmark three-year bond, citing market conditions.

Spain’s short-term borrowing costs started approaching the levels of longer-term yields last week as the gap between two-year and 10-year rates narrowed to the least in three years.

France found demand for its sale of €4.35 billion of debt in several maturities, including 10-year bonds at 3.18 per cent, less than at the November 3rd sale.

French 10-year yields fell 27 basis points, the most in 20 years, to 3.12 per cent after the auction, while Spanish 10-year bond yields declined 21 basis points to 6.015 per cent. That compares with a euro-era high of 6.781 per cent on November 17th, when Spain last auctioned bonds.

The debt sales were a test of investor confidence after the US Federal Reserve, the ECB and four other central banks in a globally co-ordinated effort on Wednesday cut the cost of emergency dollar funding for European banks.

The central banks acted after financing costs rose following euro area leaders’ failure to bolster the region’s rescue fund as planned.

“There’s a generally brighter sentiment at the moment and Spain’s was a very good auction with strong demand,” said Norbert Aul, a European rates strategist at RBC Capital Markets in London.

“There’s still fuel in the tank from policy actions and the ECB will offer more next week.”

“They were both pretty good auctions,” said Huw Worthington, fixed-income strategist at Barclays Capital in London. “The levels are higher than they would like, but the actual auctions were strong. The central bank action . . . has certainly helped.”

European stock markets came off a little yesterday. The Iseq index underperformed its European peers, shedding 1.4 per cent to close at just under 2,710. Brokers attributed some of this to profit-taking following the rally of almost 4 per cent on Wednesday.

Across Europe, the UK’s FTSE 100 fell 0.3 per cent, France’s CAC 40 fell 0.8 per cent and Germany’s DAX was down 0.9 per cent.

US stocks also retreated following the biggest three-day rally in the Standard and Poor’s 500 index since March 2009, as a decline in financial shares overshadowed a report showing that US manufacturing expanded in November at the fastest pace in five months.

Gold fell for the first time in four days after demand for the metal as a haven. It had jumped 3.7 per cent in the previous three days. The euro rose against the dollar, bolstered by the successful Spanish and French auctions. – (Additional reporting: Bloomberg, Reuters)