May 17, 2012 / 5:30 PM / 8 years ago

Spain debt costs to leap at bond sale as investors eye Greece

MADRID (Reuters) - Spain’s medium-term borrowing costs will rise sharply at auction on Thursday, with concerns over the health of the recession-hit country’s banking sector heightened by fears that Greece may leave the euro zone.

The Treasury aims to sell between 1.5 billion and 2.5 billion euros ($1.9 billion-$3.2 billion) of sovereign bonds expiring in 2015 and 2016.

But with nervous investors dropping assets from euro zone periphery countries like Spain, finding buyers may prove expensive, and it could pay around 5 percent on the longest bond - half as much again as in March.

“Market sentiment remains fragile. Combined with the weak macro backdrop, concern about political paralysis in Greece and the need to support the Spanish banking sector, risk aversion is rising,” Peter Goves, a strategist at Citi, said.

Deepening political and economic turmoil in Greece following an indecisive parliamentary election that showed growing voter resistance to European-imposed conditions for aid has fuelled expectations the country will quit the single currency.

Spain, meanwhile, has reached more than half of its debt issuance target this year, though Prime Minister Mariano Rajoy warned on Wednesday the Treasury faced trouble financing itself at a reasonable rate following the recent spike in yields.

The risk premium investors demand to hold Spanish over German debt rose to a euro-era high on Wednesday of over 500 basis points though later fell after German Chancellor Angela Merkel said she wanted Greece to stay in the monetary union.

AFTER THE FEAST?

Spanish bond yields eased from euro-era highs hit in November after the European Central Bank flooded financial markets with cheap 3-year credit lines (LTROs) in December and February.

But with liquidity running thin and Spain’s banks, which gorged on sovereign debt in the first few months of the year, forced to raise new capital under a reform of the sector introduced on Friday, demand for debt has fallen.

In the secondary debt market - a guide of how much investors can expect to pay at auction - yields of the three bonds on offer were significantly higher on Wednesday than at previous auctions of the same maturities.

On the bond maturing in January 2015, secondary market yields stood at around 4.3 percent after an average yield of 2.89 percent on April 4, while the July 2015 bond was trading at around 4.75 percent after 4.037 percent on May 3.

The longest maturity paper, April 2016, was trading on Wednesday at around 5 percent, above an average yield of 3.374 percent during a primary auction on March 15.

Despite the banking sector reform, demanded by investors that fear banks face billions of euros of potential losses from exposure to a burst property bubble, bondholders have intensified the selloff over fears of contagion from Greece.

“Contagion is back with a vengeance. (Wednesday’s) sharp rise in Spanish and Italian spreads is a foretaste of things to come...This is the most dangerous period for Spanish and Italian bond markets since the height of the euro zone crisis last November,” said Nicholas Spiro of Spiro Sovereign Strategy.

And as it struggles to reduce one of the highest public deficits in the euro zone through deep cuts to public spending and tax hikes, the government will confirm on Thursday that Spain’s economy has slipped into its second recession since 2009.

($1 = 0.7828 euros)

Reporting By Paul Day; Editing by John Stonestreet

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