LONDON: Spanish bond yields rose on Tuesday as investors fretted that efforts to recapitalise the country's frail banking sector could mean the government selling more bonds and adding to the growing pressure on public finances.
A government source said Spain would probably issue new bonds to help fund the 19 billion euro rescue of its fourth-biggest lender Bankia.
With 10-year borrowing costs approaching the 7 percent level which is viewed as a point where governments need to consider seeking a bailout, the prospect of more, expensive bond sales pushed Spanish yields up and helped safe-haven German Bund futures to rally to a new high.
"The concerns are that for the government to help the banks, the bill will be too big for Spain to pick up - that they will not be able to do this on their own. That is the real fear at the moment in the market," said Niels From, chief analyst at Nordea in Copenhagen.
The Bankia rescue may also tap cash from the country's bank restructuring fund, the government source said.
Selling bonds at high yields over a long period will raise the country's cost of financing, potentially undermining confidence and limiting access to debt markets - as Ireland and Portugal found when yields on their debt topped 7 percent.
The selloff was most evident in the short end of the curve where two-year bond yields ended the day 15 basis points higher at 4.65 percent.
Ten-year yields edged to a fresh six-month high of 6.54 percent before pulling back to close around 6.47 percent. The next level of resistance would be the euro-era highs of 6.8 percent set in November 2011, analysts said.
While there remained scope for yields to hit those new highs, some were more cautious, taking the view that the latest bout of pressure would force policymakers to step in.
"It depends on how quickly the situation worsens in Spain but we are convinced that politicians will find a solution. They know there is not much room for manoeuvre now the crisis has reached Spain with such momentum," said Norbert Wuthe, senior government bonds strategist at Bayerische Landesbank.
SAFETY BID INTACT
While Spain dominated sentiment in the periphery, the uncertainty surrounding Greece's future in the euro zone ahead of June 17 elections also provided support for relatively expensive, but low-risk, safe-haven assets.
Ten-year German Bund yields fell 1.5 basis points to a fresh low of 1.346 percent and futures contracts rose 21 ticks to a new high of 144.58.
Greece's conservatives have an opinion poll lead that would allow the formation of a government committed to keeping the country in the currency but it remains a tight race.
Any prospect of a short-term selloff was also limited by Thursday's Irish referendum on signing up to the European Union's tough new fiscal rules.
While Ireland is expected to approve the treaty, traders said there was no sign that speculative investors would looking to build up short positions in anticipation of a fall in Bunds after the vote.
"Greece and Spain continue to be the major problems right now, and I think most market participants expect Ireland to vote for the fiscal pact," Wuthe said.
Nevertheless, short-dated Irish bonds sold off for a fourth consecutive session. Two-year yields came within 6 bps of those on 10-year Irish debt, nearing the point of yield curve inversion implying that investors see risks concentrated in the very near future.
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