Spain's short-term borrowing costs rose to their highest level since 1997 in a debt sale today as investors worried the country will soon be forced to ask for international aid.
The euro zone's fourth-largest economy has become the focus of the debt crisis, with Madrid struggling to overcome recession and a costly restructuring of the banking sector restructure.
Yields on Spanish 10-year bonds have been trading above 7 per cent, a level that is seen as unsustainable for Spain's shaky public finances and one at which other euro zone countries have been forced to ask for international help.
The rise in Spain's longer-term interest rates put the sale of €3 billion ($3.77 billion) of bills in the spotlight ahead of a bond auction on Thursday. There was good demand and the government met its target amount but the yield on the 18-month paper was the highest since November while the 12-month bill sold with the highest rate since before the birth of the euro.
"The yields are over 5 per cent in both lines which is back at the levels we saw in November 2011 when the market was in huge distress and the ECB was forced to intervene," Credit Agricole rate strategist Peter Chatwell said.
Spain's economy is under pressure and earlier this month asked Europe for up to €100 billion to recapitalise its banking sector, suffering from a property market crash and a rise in bad debts. The government was keen to avoid asking for a full-scale sovereign bailout such as the ones taken by Ireland, Greece and Portugal.
With the Spanish economy more than twice the size of these three combined, economists say the rise in borrowing costs and the worsening outlook may soon force it to seek fresh aid.
The EU has a potential rescue fund of around €700 billion, but if Spain needed an aid package of a similar size to that of Ireland and Portugal before it, Madrid alone would suck up more than half of that, leaving the euro zone badly exposed if Italy also got into trouble.
In Mexico, G20 leaders discussed the need for Spain to clearly formulate its request for aid for its blighted banks.
"We talked about the need for clarity on Spain's application," German chancerllo Angela Merkel told reporters today in Los Cabos. "We all know that banks that aren't properly capitalized are a sources of turmoil and risk."
Spain entered its second recession since 2009 in the first quarter and most economists expect the economy to continue to shrink into next year at least.
Unemployment is over 24 per cent, more than half all young Spaniards are out of work and deep spending cuts to tame one of the euro zone's largest public deficits are expected to prolong the downturn as investment plummets.
Protests against the austerity measures, which include deep cuts to the country's treasured public health and education sectors, have been large and frequent but mostly peaceful.
Borrowing costs fell sharply after the European Central Bank flooded the market with around €1 trillion in cheap credit through two long-term refinancing operations (LTROs), in December and February, but they have since leapt back up.
Spain is hoping the ECB will ride to its rescue again. Officials have repeatedly said the central bank needs to take action to stop the euro zone debt crisis from getting worse.
The country sold €2.4 billion of the 12-month T-bill at an average yield of 5.074 per cent today, compared with 2.985 per cent at the last auction in May. It sold €639 million of 18-month paper at an average yield of 5.107 per cent after 3.302 per cent last month.
Spain will face a bigger test in financial markets on Thursday when it auctions up to €2 billion of bonds maturing in 2014, 2015 and 2017.
