Spain's borrowing costs rise to record high

THE ELECTION victory for pro- austerity parties in Greece failed to assuage fears over the euro zone’s future, as investors ratcheted up the pressure on policymakers by sending Spain’s benchmark borrowing costs to a new euro-era high.

Markets initially rallied on news that New Democracy and Pasok, two mainstream parties that support the austerity conditions of the euro zone’s bailout, gained enough seats to form a parliamentary majority in Athens.

But the optimism was swiftly deflated by dismal bad bank loan figures in Spain that underlined the country’s woes.

Data from the Bank of Spain showed that the non-performing loan ratio of Spanish banks rose to 8.7 per cent of their outstanding portfolios in April – the highest in almost two decades.

The euro zone has already promised €100 billion to help recapitalise Spain’s banks, but investors are concerned that it could merely increase Madrid’s debt burden and eventually lead to a full sovereign rescue. Spain’s 10-year bond yields, which move inversely to prices, rose as high as 7.28 per cent yesterday, while the euro fell sharply against most other key currencies.

Italy’s 10-year bond yields again rose above the 6 per cent mark.

“The Greek election merely postpones a consideration of the underlying problems,” said Sushil Wadhwani, a hedge fund manager and former member of the Bank of England’s monetary policy committee. “The markets are tiring of things that buy a little time and do not deal with the underlying issues.” Athens’s stock market hung on to a small rise, but most other European equity markets reversed their initial gains. The euro lost further ground versus the dollar, and Italian and Spanish bond markets tumbled. Investors and economists say that the euro zone crisis has moved to an “endgame”, where little less than substantial central bank intervention in the short term and moves towards a longer-term European fiscal union will assuage markets.

“It’s not really about countries any more, it’s about trying to come to terms with a deep systemic issue and what Europe should be doing about it,” says George Magnus, senior economic adviser to UBS.

At the start of the G20 summit in Mexico, José Manuel Barroso, European Commission president, indicated that the terms of Spain’s banking rescue were still up for negotiation and acknowledged fears that the banking and fiscal crises are increasingly intertwined: “We have been in favour, as far as possible, in avoiding any kind of contamination of financial debt and sovereign debt.”

While the commission and many euro zone countries have been in favour of using the continent’s rescue fund, the European Stability Mechanism, to inject equity directly into failing eurozone banks, Germany remains opposed and has a blocking vote on the ESM board.

Investors have begun to focus their concerns on an EU summit scheduled for the end of the month, with many hoping policymakers will make progress towards some form of banking union to prevent the bloc from unravelling.

Hopes have centred on proposals to create a common European bank supervisor and rescue fund that would shore up banks too big and too weak to be rescued by their national governments. – Copyright The Financial Times Limited 2012