LONDON: Spain's fragile grip on its fiscal independence looked ever more in doubt on Thursday after meagre demand at a bond auction pushed benchmark yields back above 7 percent, intensifying doubts over whether Madrid can avoid a full-blown bailout.
Appetite at a sale of two-, five- and seven-year bonds was sufficient to ensure Spain sold all the debt it needed, but the difference between the lowest and the average bid was relatively wide, reflecting badly on the quality of the bidding.
That helped nudge the benchmark 10-year yield 8 basis points higher and above 7 percent for the first time in more than a week - beyond the level markets fixate on as a dividing line between sustainable and unsustainable borrowing costs.
"The risk is that yields could start rising also in shorter maturities where Spain is doing most of the funding, and that will basically be 'game over' for Spain," said Gianluca Ziglio, a strategist at UBS in London.
The average yield on the five-year bond was 6.459 percent, rising from 6.07 percent at a comparable sale in June and in stark contrast to a French bond sale which saw debt with a similar maturity sold for just 0.86 percent.
The schism illustrates the widening gap between states at risk of needing an international bailout and those still viewed as an appealing investment.
Spain is struggling to persuade 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.
The expected approval of a banking sector bailout worth up to 100 billion euros by euro zone finance ministers on Friday was so widely anticipated that it was unlikely to bring much relief to the market, analysts said.
CATCHING UP
German debt futures slipped and benchmark bond yields inched higher but bonds issued by the euro zone's other highly-rated states again performed strongly, extending a trend that has seen French and Belgian spreads over Bunds narrow.
The strength of the rally in bonds that are non-German, but still have a solid credit rating, has been fuelled by a hunt for returns and may have further to run as sky-high demand for perceived safe assets drives ever more bond yields negative.
"You might expect those countries to go further, anything positive (in yield terms) is going to be appealing," said Chris Scicluna, head of economic research at Daiwa Capital Markets.
"We've got Belgium two-years around 20 basis points above zero so I would imagine that's got further to go, as has France which could get down to zero."
Only a couple of months ago, investors fretted contagion could quickly spread from peripheral bonds to France, given its banks' sizeable exposure to debt issued by Spain and Italy.
But as yields in two-year German bonds have settled in negative territory, the extra yield on French debt has seen it emerge as a favoured alternative among investors.
The premium investors require to hold two-year French bonds over their German equivalent has fallen 24 basis points so far this month, with the Belgian equivalent down 42 bps.
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