Rating cut drives Spanish yields higher

LONDON: Spanish government bond yields rose on Thursday after a credit downgrade pushed the country to within a whisker of the 'junk' rating that would force some investors to pull their cash out of Spain.

Standard and Poor's cut Spain's rating to BBB-minus, with a negative outlook, just one notch above non-investment grade and in line with peer Moody's, which is expected to conclude its own rating review on the country soon.

 "Clearly now the pressure is back on Spain. The Moody's verdict is looming and we could get more bad news on that front," said Commerzbank strategist Michael Leister.

The S&P move raises the likelihood that Spain could be rated below investment grade by two agencies in the near future, which would cause it to drop out of some major bond indexes and force selling by investors who track such benchmarks.

"There's still some room left but as we've seen with other index events, investors will pre-empt these moves to some extent," Leister said.

Spanish 10-year yields rose 10 basis points to 5.92 percent while the move towards less risky assets saw investors buy German Bund futures, which rose 45 ticks to 141.68.

But Spanish 10-year bond yields still remain well below the high of 7.8 percent they hit in July, kept in check by the European Central Bank's commitment to buy the country's debt if Madrid seeks an external aid programme from its euro zone peers.

Despite growing impatience over Spain's perceived slow progress toward making a bailout request, the market pressure has so far been modest because few want to be caught betting on rising yields if the ECB starts buying debt.

"Bad news for Spain might be seen as just pushing them closer to a bailout request. It is difficult to short (or) underweight the bonds when you know that the ECB is standing on the sidelines," said Gary Jenkins, director at Swordfish Research.

 The risk-averse mood in the market comes at an awkward time for Italy, another euro zone sovereign struggling with debt problems, which will sell up to 6 billion euros of bonds later in the day.

 "This could increase the pressure but I don't imagine there will be huge consequences," said ING strategist Alessandro Giansanti.

He said the short-term nature of most of the debt on offer, and the fact that Italy is currently seen as less of a risk than Spain, was likely to ensure demand, although yields may well be higher as a result of the downgrade.

Italian 10-year yields were up 5 bps on the day at 5.15 percent while two-year yields rose by the same amount to 2.61 percent -- 84 bps below their Spanish equivalent.