By EMESE BARTHA, TERENCE ROTH and NEELABH CHATURVEDI
FRANKFURT—The euro-zone debt market brushed off renewed efforts by the European Central Bank to support Italian and Spanish government bonds after new warnings on Spanish debt sustainability.
Spain was forced to offer record euro-era yields at its government-bond auction Thursday, reflecting investors' demands for higher risk premiums as Europe struggles to contain its sovereign-debt crisis.
The auction results escalated concerns that large economies previously considered safe bets could see borrowing costs rising to levels that treasuries cannot sustain over time. Greece, Portugal and Ireland lost access to market funding and had to seek bailouts after being forced to pay yields of more than 7% on their 10-year bonds. Now Spain isn't far behind, having to pay an average yield of 6.975% to sell a total of €3.563 billion ($4.8 billion) in 10-year bonds.
France also had to pay higher prices for debt at its own auction Thursday. Its treasury sold a series of medium-dated bonds, including €3.33 billion of bonds due in July 2016, for an average yield of 2.82% compared with 2.31% at the last auction.
Political crises in Greece and Italy and the threat that a new economic recession could deepen the debt crisis in other euro-zone countries have escalated concerns that the region's crisis management will deliver too little too late. A plan to construct a massive new government bailout fund, the European Financial Stability Facility, has been held up by disagreements on its functions and plans for a new bailout for Greece remain elusive. Citigroup analysts said in a note Thursday that the battle for issuers such as Italy and Spain to retain market access has reached a "critical stage."
Questions have been raised over the firefighting capabilities of the euro area's rescue fund when Italian bonds were selling off in recent days. If Spanish yields spiral higher and the country finds it unsustainable to raise funds in the market, the EFSF in its current form won't be able to shore up both Italy and Spain. Italy alone will probably need to sell around €440 billion of bonds and bills in 2012, Italian debt officials said this week.
Rising government borrowing costs for the euro zone's bigger countries put increasing pressure on the ECB to commit to longer and more decisive support for sovereign-bond markets to prevent the debt crisis from spreading and escalating.
The ECB for months has been purchasing Italian, Spanish and Portuguese bonds to support those markets in what it sees as a temporary stopgap. But the euro's central bank has resisted calls to commit to permanently becoming the region's lender of last resort, which it believes conflicts with its strict monetary mandate to guard against inflation and not encourage governments to relax fiscal reforms.
The ECB has been backed up by Germany and its central bank, the Bundesbank, with arguments that the ECB must be held back from monetizing debt and risking a surge in inflation like the one that plagued Germany's Weimar Republic in the 1920s.
German Chancellor Angela Merkel on Thursday reinforced her opposition to expanding the ECB's role in supporting sovereign-debt markets, saying that this wouldn't immediately solve the euro-zone crisis. Since starting its bond-buying program last year, the ECB has bought nearly €187 billion of government bonds.
Even with ECB support, Italy still has periodically crossed that critical threshold over the past week. And Spain showed at its Thursday auction that it was now fast coming up to that level for 10-year debt.
French 10-year yield spreads over yields on comparable German bonds, the market's benchmark, have hit euro-era highs of just shy of two percentage points.
German bonds remain the gold standard among what is considered to be the core euro-zone countries, analysts say. This leaves most all other issuers facing higher borrowing costs in future auctions unless there is a substantial policy response from the ECB or the International Monetary Fund. "There are probably no sweet spots on the calendar for the [euro-zone] ex Germany countries to sell bonds these days," Commerzbank economists said in a note.
In the secondary markets Thursday, the yield on the benchmark 10-year Spanish bond soared 0.35 percentage point to 6.7%, the highest level since the inception of the euro, according to Tradeweb data. The extra yield demanded by investors to hold Spanish bonds due in 10 years instead of safe-haven German bunds widened by 0.37 percentage point to 4.93 percentage points, also a record in the euro period.
One wild card is Spain's general elections on Sunday, which are expected to unseat the socialist government. But market watchers don't see that outcome making a difference.
"With the ECB reluctant to completely fill in the vacuum left by fleeing investors, pressure on Spanish bonds will likely persist after a new government is place," said Mark Chandler, global head of currency strategy at Brown Brothers Harriman.
French bonds also sold off Thursday, with the 10-year yield climbing by 0.09 percentage point to 3.77%. The 10-year French/German yield spread climbed to a euro-era high of 2 percentage points.
