LONDON: A rise in safe-haven German bond prices after Spain said it was becoming shut out of bond markets proved short-lived on Tuesday, suggesting some investors see a growing chance the country will take external help for its banks.
Treasury Minister Cristobal Montoro said the country's high borrowing costs meant "Spain doesn't have the market door open", adding that the European Union should help to recapitalise its fragile banking sector.
That upset jittery investors, increasing demand for the safety of German debt futures, which rallied to a session high of 146.34 before appetite for riskier assets recovered, also helped by solid US economic data.
Bund prices were last flat on the day in thin trade on the second of two bank holidays in Britain.
Worries that the cost of rescuing Spain's banks may be too high for the country's already-stretched public finances sent the risk premium on Spanish debt to a euro-era high last week while German debt prices rallied to record levels.
However, Bund futures have retreated from those highs and Spanish 10-year bond yields fell 9 basis points on Tuesday to 6.32 percent, with traders citing growing momentum behind calls for fresh crisis-fighting measures from Europe's policymakers.
"What we have learnt since the weekend is that all the talk about a bigger solution, a bigger response from the politicians is gaining some steam," said Rainer Guntermann, strategist at Commerzbank in Frankfurt.
"At the same time it doesn't look like they have a quick fix at hand, not a fundamental game changer at this point in time."
Emergency talks between G7 financial chiefs produced verbal support for the euro zone in light of Spain's problems and the possibility that Greece may be forced to leave the bloc, but little sign that concerted action was imminent.
The prospect of a decisive crisis response from politicians before a EU summit on June 28-29 looked slim, leaving the focus on a Spanish debt auction of up to 2 billion euros of medium- and long-term bonds on Thursday.
While analysts shared Montoro's view that Spain's borrowing costs are too high, they said Madrid still had market access.
"I don't think markets are closed for Spain.
I think he meant to say something else," BNP Paribas rate strategist Patrick Jacq said, adding that the small size of Thursday's auction should ensure the sale will not flop.
"If the recent bias on Spanish yields will go on further, especially for the five- to 10-year area, at some stage it will be a big problem for Spain ... but so far it's manageable."
POLICY HOPES
Some in markets speculated the European Central Bank may come up with steps to defuse the crisis at its regular policy meeting on Wednesday.
Speculation the ECB may ease monetary policy has grown in recent days, but such bets carry high risk. Most economists in a Reuters poll expect the central bank to hold fire.
ING rate strategist Alessandro Giansanti estimated the forward overnight Eonia euro interbank rate market priced in a 22 percent probability that the ECB will cut rates by 25 basis points from a record low of 1 percent.
"Markets are still speculating on that and also on some kind of measures on the banking side, like creating some kind of deposit insurance or allowing the EFSF or ESM (bailout funds) to directly help banks," Giansanti said. "There is still a lot of uncertainty regarding policy actions."
Other clues to possible policy steps may come in testimony by US Federal Reserve Chairman Ben Bernanke on Thursday.
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