* Bund futures hit contract high as Greek debt hammered
* Prospect of Greek default fuels banking system worries
* Continued ECB support seen essential to Italian auctions
By William James and Marius Zaharia
LONDON, Sept 12 (Reuters) - December Bund futures rose to a contract high and Greek bond prices sank to new lows on Monday as investors saw a growing chance Greece would be forced to default on its debt — bringing the strength of the region’s banking system into question.
The prospect of repeated fiscal slippages causing Greece to lose aid funding and default raised worries about French banks — large holders of Greek debt — and was seen continuing to push demand for the relative safety of German Bunds higher.
“It’s not so much the information about Greece now, it’s more about the fears of the domino effect if Greece has to do a hard restructuring,” said Nordea’s chief analyst Niels From.
The December Bund future hit a contract high at 138.61, up by three-quarters of a point, and the yield on the largely-illiquid market for short-dated Greek debt soared by 19.8 percentage points to almost 83 percent.
Shares in French banks tumbled by more than 10 percent on the day and the euro weakened against the dollar , sinking to a seven-month low before paring some of those losses.
Ten-year Bund yields hit a low of 1.707 percent and RIA Capital Markets strategist Nick Stamenkovic expected a further fall towards 1.5 percent in the absence of any positive news in the near future.
Markets were unimpressed by Greece’s latest efforts to ensure it meets fiscal targets necessary to ensure a continued supply of bailout funding.
The Greek/German 10-year bond yield spread expanded by around 270 bps to a record 2,167 bps and the cost of insuring against a default on bonds issued by Greece hit new highs.
Markit said Greek CDS was quoted at an up-front rate of 57 points, meaning that to take out 10 million euros of insurance, investors were being asked to pay 5.7 million euros at the start of the contract and 100,000 euros per year after that.
“The light is flashing red for Greece,” said John Davies, fixed income strategist at WestLB. “The market is extremely fearful that a Greek default may be coming much sooner than being anticipated a few months ago.”
Italian CDS also hit record highs above 500 bps as markets fretted over the country’s ability to raise money at affordable rates to finance its huge debt burden.
RIA’s Stamenkovic said the next key events to watch were Italian and Spanish debt auctions this week, which will test the European Central Bank’s drive to buy government bonds and keep the crisis from spreading to large economies.
Uncertainty over its appetite for more bond purchases was heightened by Friday’s unexpected resignation of the ECB’s chief economist Juergen Stark.
The central bank said purchases worth 13.96 billion euros were settled last week, up slightly from the previous week.
Analysts said there was little scope for weekly purchases to decrease much from this level with investors still reluctant to buy up new bonds at auctions held by the region’s embattled sovereigns.
Italy plans to sell up to 7 billion euros worth of debt on Tuesday, while Spain plans to issue up to 4 billion euros of bonds on Thursday.
The Italian 10-year bond yield rose 16 bps to 5.58 percent, widening the spread versus Bunds to 382 bps. The equivalent Spanish bond yield rose 17 bps on the day to 5.34 percent, some 358 bps over Bunds.
Moody’s is also expected to finalise its ratings review of Italy this week, with analysts saying any move that goes beyond one notch will intensify tensions in fringe euro markets. (Graphic by Scott Barber)