June 18, 2012 / 10:12 AM / in 5 years

Spain, Italy demand action as debt pressure mounts

MILAN/MADRID (Reuters) - Spain called on Monday for the European Central Bank to fight financial market pressures on the euro zone, and Italy said more must be done to shore up the bloc after the Greek election result failed to ease the strain on both countries.

The cost of borrowing rose for the two big euro zone economies under fire for poor finances, widening the gap between what they would have to pay and what Germany pays.

The yield on Spain's 10-year bond went above the 7 percent widely viewed as unaffordable. Italy's was just above 6 percent.

Spanish Treasury Minister Cristobal Montoro told the Senate during a budget hearing that doubts were lingering about the future of the euro zone. "The ECB must respond firmly, with reliability, to these market pressures that are still trying to derail the joint euro project," he said.

Within a few hours of Sunday's Greek election result - a narrow win for Greek parties committed to a European Union/International Monetary Fund bailout - financial markets were reacting as if nothing had changed.

"We can see that the markets are not convinced," Italian Prime Minister Mario Monti said at a G20 meeting in Mexico, according to Italian news agency ANSA. "We must draw up a definitive and clear road map with concrete actions that make the euro more credible."

Spanish Prime Minister Mariano Rajoy, like Montoro on Monday, has repeatedly called for the ECB to act to defend the euro zone, implicitly wanting it to resume a massive bond-buying program that held down yields of government debt in recent months. The ECB is reluctant to fire up the program again.

Monday's market response underlined the problem facing the euro zone: short-term improvements in the climate do not get away from the fact that finances are perilously tight in the middle of an economic downturn.

"While Greek euro exit fears have ... eased, this (election) outcome does little to alleviate the weak fundamentals that currently weigh on Spain and Italy," Michala Marcussen, an economist at Societe Generale, said in a research note.

Even so, a meltdown at the prospect of a Greek government promising to renege on its commitments and possibly forcing Greece out of the euro zone was averted

Rajoy greeted the election outcome as "good news for Greece, very good news for the European Union, for the euro and also for Spain".

Comprehensive Solution

For Italy and Spain, the bond market reaction to the Greek vote suggested that the euro zone crisis needs a comprehensive solution before markets can start to build confidence.

Stock and currency markets were also underwhelmed by the Greek results. After an initial rise, Europe's top shares and the euro were weaker.

Skeptics don't have to look far to see why: Spanish banks' bad loans rose to the highest percentage of their outstanding portfolios since April 1994, according to the Bank of Spain.

An audit later this week is expected to show Spanish banks need between 60 billion and 70 billion euros ($75-88 billion) in capital.

There were mixed signals from Germany about whether it would tolerate a slight easing of demands on Greece.

It is also unclear how deep the divisions will be between German Chancellor Angela Merkel and French President Francois Hollande over easing back on austerity programs in favor of economic growth. These questions keep markets on edge and drive investors away from what they see as riskier assets.

"Our concern remains that little will be delivered in terms of additional risk-sharing measures, leaving markets, and as such the economies, vulnerable to renewed stress," said Marcussen of Societe General.

Writing by Jeremy Gaunt; Editing by David Stamp

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