EURO GOVT-Spanish debt suffers as bank bailout costs weigh
* Spanish/German yield spread hits euro-era high 512 bps
* Rising Bankia bailout costs weigh, yield hits 6.5 pct
* Bunds ease as Greek polls give pro-bailout parties lead
By William James
LONDON, May 28 (Reuters) - The risk premium on Spanish debt hit a euro-era high on Monday, and looked set to keep rising as investors factored in the growing cost to the public purse of shoring up the country's banking sector.
A Spanish government source said the country may use government debt to recapitalise its fourth-largest lender Bankia , which last week asked for a 19 billion euro bailout to stem losses related to soured property loans.
"Spain is under a lot of pressure right now on Bankia and the never-ending cost of the bailout there," a trader said.
The plan could bump up Spain's national debt, adding pressure to public finances already strained by stifling austerity and weak growth. On Friday, the country's wealthiest autonomous region said it would need government help to plug a funding gap.
The gap between Spanish and German 10-year bond yields, which measures the risk investors attach to holding Spain's debt rather than safe-haven German Bunds, widened to 512 basis points - its widest in the 13-year history of the euro.
The 10-year Spanish bond yield rose to 6.5 percent, reaching its highest since November 2011 when the European Central Bank was forced to step in and buy the country's debt to bring yields down.
As borrowing costs climb towards their record high of 6.8 percent, investors will grow increasingly wary of the added burden of refinancing maturing debt at such high levels.
"It will take a bit of time before it drives up the average cost of funding, but we're talking about only being comfortable with that for a month or two," said Elisabeth Afseth, analyst at Investec in London.
"If it goes on for much longer it just adds to the burden of fiscal consolidation. If a large part of that is spent on paying a premium to borrow, it just makes it so much harder."
Ireland and Portugal were frozen out of capital markets and forced to seek international bailouts soon after their yields topped 7 percent. It is unclear whether current bailout provision would be enough to rescue Spain.
Trading volumes were low with parts of Europe closed and the U.S. market shut until Tuesday due to a public holiday.
GREEK RELIEF, FOR NOW
Despite the rising concern about Spain, worries over Greece and its future in the euro zone were calmed by signs the country may be able to form a pro-bailout government following its June 17 elections.
German Bund futures eased 17 ticks on the day to 144.06, after hitting a record high of 144.55 last week, when Greek voters looked to be backing parties that might abandon the terms of its bailout deal ahead of a June 17 election.
Opinion polls over the weekend showed Greece's conservatives have regained a lead that could allow them to form a government committed to keeping the country in the euro zone.
Nevertheless, few in the market saw German debt falling far in the run-up to the elections while policymakers continue to make little progress towards a longer-term solution to the region's problems.
"I don't know if it makes sense in the medium to long term to have Bunds at these expensive levels, but until we get some kind of decent shot at a resolution in Europe they're going to remain very well-bid," the trader said.
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