MADRID Spain's five-year borrowing costs hit new euro-era highs at an auction on Thursday while France paid less than 1 percent for similar bonds as investors increasingly marginalize southern economies from what they see as the euro zone's safer core.
Spain is struggling to convince investors it can control its finances and meet strict deficit guidelines by slashing spending and hiking taxes while also dragging its economy out of a prolonged recession.
Madrid detailed additional austerity measures on Friday but they have done little to soothe investor nerves. German Finance Minister Wolfgang Schaeuble knocked the euro on Thursday when, urging lawmakers to approve Berlin's contribution to a euro zone aid package for Spain's ailing banks, he said the slightest perceived risk of Spanish insolvency could trip up the entire 17-nation bloc.
The 6.459 percent yield on Spain's July 2017 bond was almost 40 basis points higher from the previous sale just a month ago, at levels not paid by the Treasury in 16 years, with investors preferring French paper even at rock-bottom returns.
"For Spain, it's combination of the economic uncertainty and the bleak economic outlook. France has its problems as well, but they're on a totally different scale than what we're seeing in Spain and Italy," Capital Economics economist Ben May said.
The euro zone's largest economy Germany sold bonds at a negative yield for the first time on Wednesday, and other highly rated euro zone states have also found investors willing to pay to hold their debt as they emphasize capital preservation.
That has led others to seek returns in relatively higher-yielding French paper, but buyers continue to shun riskier sovereign borrowers such as Spain even at bumper yields.
Euro zone finance ministers are due to sign off on up to 100 billion euros of aid for Spain's battered banking sector on Friday, though economists are increasingly concerned that Madrid may need a rescue package of its own.
Spanish borrowing costs jumped on all three bonds offered, with the longest-dated, a seven-year, coming in near the 7 percent mark beyond which other euro zone countries have been forced to seek aid.
After the auction, yields on 10-year Spanish debt trading in the secondary market climbed back above 7 percent, with the spread versus German Bunds, seen as the euro zone's least risky asset, close to record highs at 582 basis points.
In total, Spain sold 3 billion euros ($3.68 billion) of bonds - at the top end of its targeted range, although demand was softer than for previous auctions.
France meanwhile sold 8.96 billion euros of bonds maturing in 2015, 2016 and 2017, including 4.5 billion euros of five-year debt at a yield of 0.86 percent.
"We're still waiting for (Spain's) bank bailout to be finalized and there's no guarantee that Spain itself won't need a bailout at some stage, so why would people want to be charging in right now?" said Monument Securities strategist Marc Ostwald.
Profits at one of Spain's healthier lenders, Bankinter (BKT.MC), fell over 77 percent in the first half after a hit from toxic real estate assets, leaving rivals braced for a tough earnings season amid a deep clean of soured property loans.
PUNCTURED TYRES, ANGRY CIVIL SERVANTS
Spain's autonomous regions, which form a major part of public spending, are showing growing signs of discontent as the central government pushes them to make more cuts to help bring the country's public finances under control.
While the politicians start to rebel, protests on the streets are also gaining momentum.
Austerity-weary Spaniards, facing a deep recession that is expected to last until the end of next year at least, have been voicing their anger and impromptu marches by public sector workers facing cuts have become commonplace in the capital.
Protesters punctured the tires on dozens of police riot vans and angry civil servants stopped road traffic in several key avenues of Madrid on Thursday ahead of evening marches called by unions in more than 80 Spanish cities.
Friday's new measures - worth 65 billion euros over the next two years - to reduce one of the euro zone's highest national deficits, include scrapping public workers' Christmas bonuses and a 3-percentage-point rise in value-added tax.
Treasury Minister Cristobal Montoro said in parliament earlier on Thursday that the government had no other choice than implementing these cuts as the country was on the verge of losing control of its finances.
Unemployment is more than double the European average, with almost a third of people out of work in the euro zone living in Spain, while the government struggles to reinvent an economy hobbled by a burst property bubble.
Spain's 1.1 billion euro sale of 5.5 percent bonds maturing July 30, 2017 was 2.1 times subscribed compared to 3.4 times in June, with its average yield of 6.459 percent up from 6.072 percent when the five-year bond was last sold in June.
The Treasury also sold 1.4 billion euros worth of 3.3 percent bonds due October 31, 2014 at an average yield of 5.204 percent -- sharply higher from 4.335 percent last month, with the bid-to-cover ratio falling to 1.9 from June's 4.3.
The 4.5 percent bond maturing October 31, 2019 was sold at a yield of 6.701 percent, also a leap from 4.832 percent when it was last sold in February. The Treasury placed 548 million euros worth of the bond, with bids worth 2.9 times the amount on offer, compared with 3.3 at the last sale.
Spain has raised almost 69 percent of its original medium- and long-term debt target of 85 billion euros for the year, but new deficit targets and a central government promise to help the country's struggling regions mean the gross target is expected to increase by more than 20 billion euros. ($1 = 0.8154 euros)
(Additional reporting by Madrid Newsroom, London debt desk; Editing by Julien Toyer and Catherine Evans)