Spain pays sharply higher rates in debt auction

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By DANIEL WOOLLS, Associated Press

MADRID (AP) — Spain's borrowing costs soared in a pair of short-term auctions Tuesday as investors worried that the country would not be able to manage an expensive rescue of its ailing banking sector.

The Treasury auctioned €3.1 billion ($3.9 billion) in the two maturities, just above its target range, and demand was strong.

But the cost was very high — an indication that investors are concerned that the Spanish government will be stuck with huge expenses after a European bailout of its fragile banking system.

The interest rate on 3-month bills was 2.36 percent, nearly triple the 0.85 percent paid in the last such auction on May 22. The rate on the 6-month bills was 3.24 percent, nearly twice as much as the 1.7 percent paid in May.

The auction came a day after Spain formally requested financial aid for its banks from its partners in the eurozone. The move was a formality — it had expressed its intent a week early.

Once again, Economy Minister Luis de Guindos did not say how much of the €100 billion ($125 billion) lifeline on offer the country planned to use.

While the bailout will help the banks, the government is ultimately responsible for repaying the money. That has raised fears that it will be stuck with huge liabilities and that's evident in the country's borrowing costs.

Addressing a parliamentary commission Tuesday, de Guindos also said no new austerity measures have been set by Brussels as conditions for the loan.

That could irk other bailed-out countries that did have string attached to their rescues. However, on Monday Prime Minister Mariano Rajoy did say Monday that new "economic measures" were in the works even though the Spanish economy is back in recession. These are widely understood to include an increase in the sales tax, a tax on goods and services.

The new conservative Spanish government has already enacted a wave of spending cuts, raised income and property taxes and frozen civil servant wages.

De Guindos reiterated that Spain's three biggest banks -- Santander, BBVA and CaixaBank -- will not need aid to meet new capitalization requirements. He said the aid requested will not surpass the €100 billion the government has available, and that terms of the loan are being negotiated. These terms are expected to be announced by July 9.

The minister said that banks which do accept loan money might have to separate toxic assets from clean ones, although he did not go so far as to say Spain will create a bad bank. So far the government has resisted such a step, which de Guindos said the EU wants.

He said this asset separation would be an additional step for individual banks that need it, aside from measures applying to the whole banking sector in Spain. He did not elaborate.

A key problem for Spain is that its banks hold massive amounts of its government bonds. So as those bonds lose value, the banks take losses, fueling a vicious cycle of uncertainty over the banks' and the government's finances.

Those concerns were evident in Moody's decision Monday to downgrade 28 Spanish banks, including international heavyweights Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA. The agency cited the banks' exposure to the government's bonds and said they are vulnerable to further losses from Spain's real-estate bust.

"The problem facing Spanish banks, which is again being reflected in rising Spanish bond yields, is that no-one is clear on how much bailout money Spanish banks will end up needing," said Michael Hewson of CMC Markets.

Hewson noted that it also remains unclear what conditions will come attached to the aid for Spain's banks. If, in the event one of the rescued banks fails, the eurozone bailout fund gets the right to be repaid before other creditors.

The Moody's downgrade had been widely expected and stock markets were mostly steady on Tuesday.

But tensions remained high in bond markets. In the secondary bond market, where auctioned debt is traded freely, the yield on Spanish 10-year bonds edged up 0.23 percentage points to close at 6.81 percent, a painfully expensive rate. The yield last week punched through the 7 percent level, a level seen as unsustainable over the long term.

Meanwhile, the Finance Ministry reported that the central government budget deficit had soared to 3.41 percent of GDP in the first five months of 2012, just 0.09 percentage points below the targeted figure agreed with the European Union for the entire year.

Spain has agreed to aim for an overall deficit of 5.3 percent of GDP for 2012 based on a projected 3.5 percent figure for the central government, 1.5 percent for regional governments and 0.3 percent for town halls.

Tuesday's figure, up 30 percent on the same period last year, was due to advance payments to regional governments, increased Social Welfare costs and reduced income, the ministry said.

Spain is battling to slash its deficit, which was 8.5 percent last year, to the EU limit of 3 percent of GDP by 2013.

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Ciaran Giles contributed to this report.

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