SPAIN CAME close to its first debt auction failure yesterday, highlighting the funding problems for weaker euro zone economies.

The government’s difficulties in selling €6.44 billion in one-year and 18-month bills sparked worries over its 10-year debt auction tomorrow.

It planned to issue €8 billion yesterday, but only just attracted that amount of bids, with yields at record highs. This prompted debt managers to reduce the size of the sale by €1.56 billion. Normally a government bill auction would be covered at least 1.5 times.

Steven Major, head of fixed income at HSBC, said: “The Spanish auction was very disappointing and does not bode well for further issuance. It’s becoming more apparent just how difficult it is for Spain, which is a big worry so soon after the launch of the international rescue package. It suggests the European Central Bank may have to buy a lot more bonds than it first thought to prop up some of the peripheral euro zone bond markets.”

The ECB has so far bought €16.5 billion in government bonds, mainly short-dated Greek, Portuguese and Spanish debt. Some analysts say the central bank may have to buy up to €600 billion to maintain stability in the markets.

Spain’s problems contrasted with successful auctions of Dutch and Irish bonds. The Dutch sold €5 billion worth of 30-year bonds in one hour. Ireland sold €1.5 billion in four-year and 10-year bonds, both more than three times covered. The Dutch have relatively healthy public finances and are rated triple A, whereas Ireland has convinced the markets it can push through tough austerity measures.

It shows how investors are differentiating, not just between core euro zone countries, but between the peripheral countries of Greece, Portugal, Spain, Ireland and Italy. Italy successfully sold five-year and 15-year debt last Thursday with relatively low yields. Most investors remain sanguine about its public finances.

Portugal also successfully sold short-term debt last Wednesday, although this was partly helped by the ECB shoring up the markets early last week. Investors remain concerned over the U-turn by the ECB, forced to back down from its resistance to buying euro-zone government bonds as part of the €750 billion support package.

Many think the central bank will have to introduce full-blown quantitative easing, which involves expanding the money supply as planned sterilisation measures could prove difficult if it has to buy large amounts of bonds.

Sterilisation involves selling other assets or draining cash from the euro-zone system to pay for bond purchases. – (Copyright The Financial Times Limited 2010)