* Spanish 10-year yields hit 11-year highs
* Markets find little relief in Madrid bond sale
* Bunds rally as Greek situation deteriorates
By Kirsten Donovan
LONDON , Jun 16 (Reuters) - Spanish 10-year government bond yields hit 11-year highs on Thursday and other peripheral bonds suffered after tepid demand at a Spanish debt auction added to concerns that Greece’s debt crisis is spilling over.
Fears that policymakers are struggling to find a solution to avoid a default for debt-laden Athens combined with worries over the stability of the Greek government to push investors into safe-haven core debt.
That supported a French bond sale but did little to help a 2.8 billion euro auction of 10- and 15-year Spanish paper [ID:nLDE75F0U9].
“We’ve already seen a decent concession going into the (Spanish) auction so they had to concede quite a substantial amount to investors in order to get them to buy,” said WestLB rate strategist Michael Leister.
“As we saw in Greece and the other countries, you can fund yourself and get liquidity but the crucial issue at some point in time becomes the price. Here it seems Spain is clearly heading in the wrong direction.”
Spanish 10-year bond yields ES10YT=TWEB rose to 5.75 percent after the sale, up over 18 basis points on the day. Greek and Italian bond yields were also higher while the cost of insuring against a Greek default jumped over 120 basis points.
Others thought Spain would be able to continue funding itself.
“You will still see liquidity being made available for Spain,” a trader said.
“You do get the international buyers at the margin but the domestics are still the big supporters of this market. I don’t think that’s going to change.”
The jitters supported German Bunds, with futures FGBLc1 up 46 ticks at 126.41, having tested their highest levels since early December at 126.62. Ten-year bond yields DE10YT=TWEB were down 3.5 basis points at 2.93 percent.
With Athens teetering on the brink of a debt default, European Union officials said agreement on a second bailout for Greece could be delayed until mid-July amid disagreement on how private investors should share the burden [ID:nL3E7HG0P8].
Meanwhile, a senior IMF official said he was very concerned by the latest political turmoil in Greece, where the government is facing a no confidence vote next week. [ID:nLDE75F0PP]
“The clock is ticking on Greece, there’s no European unity and Athens doesn’t have the political consensus to push through reforms,” said another trader.
“The market wasn’t positioned for the Greek situation to deteriorate to this degree so the rally can run for a while yet.”
The souring sentiment helped France sell 7.99 billion euros of reopened two-, and three-year bonds and new five-year bonds in a smooth auction. France will sell up to 2 billion euros of inflation linked paper [ID:nTAR01181].
Meanwhile, ECB Governing Council member Nout Wellink called for the European bailout fund to be doubled in size to take into account the contagion risk for Ireland and Portugal should Greek get a new aid package. [ID:nLDE75F03M]
“The risk now is that some kind of accident happens, be it the European elements can’t agree a solution ... or what happens if the Greek government falls?” said RBC rate strategist Peter Schaffrik.
Reuters’ calculations based on five-year credit default swap prices from Markit showed an 80 percent probability of Greece defaulting on its debt based on a 40 percent recovery rate.
Similar calculations for Portugal and Ireland showed around a 50 percent probability of default.
“There is no sovereign in the world that trades wider than Greece now, the closest is probably Venezuela. Greece is out there on its own,” said Markit analyst Gavan Nolan.
Concern about the U.S. economy was also underpinning Bunds after U.S. Treasuries surged on Wednesday following a weak regional manufacturing report.
European stocks fell, with banks among the heavy fallers as investors shunned riskier assets and the euro EUR= hit a three-week low, breaking below its 100-day moving average.
Traders also said Ireland’s decision to seek to impose losses on senior bondholders in Anglo Irish Bank [ANGIB.UL] was an “ominous” development, adding to concerns about the effect of a Greek default or restructuring on the banking sector [ID:nWLA2611]. (Reporting by Kirsten Donovan; editing by Patrick Graham)