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Spanish debt risk premium hits record high

Investors fled Spain’s bonds Monday and pushed its risk premium to a record high as Ireland’s 85-billion-euro rescue failed to vanquish fears of a spreading eurozone debt crisis.

Concern swept the debt markets that despite the lifeline thrown to Ireland, the crisis might yet engulf Portugal and then Spain, an economy twice the size of Ireland, Portugal and Greece combined.

In the climate of fear, traders demanded increasingly high yields before taking a bet on Spanish debt.

Spanish 10-year bond yields peaked in mid-afternoon trade at just under 5.46 percent, the highest since 2002, pushing the spread with safe-bet German bonds back towards record levels around 2.70 percent.

Investors paid little heed to Spain’s argument that it is no need of a rescue with accumulated public debt equal to 53.2 percent of annual output last year, well below the EU average of 74.7 percent.

“The sovereign debt crisis is escalating despite the Irish rescue package,” said Nick Kounis, head of macro research at ABN Amro.

Spain’s economy is suffering from 20-percent unemployment and it posted zero growth in the third quarter.

But its economic foundations appear better than those of Greece and Ireland, with state debt likely to remain comfortably below 100 percent of annual economic output, Kounis said in a report.

Efforts to rein in state spending in Spain were also on track, he added.

Spain’s government has suspended dozens of road and rail projects and cut civil servants’ wages.

It aims to trim the public deficit from 11.1 percent of annual output last year — the highest in the eurozone after Greece and Ireland — to 6.0 percent in 2011 and three percent, the EU limit, in 2013.

Portugal was “significantly more vulnerable” than Spain, Kounis said, with an outlook for greater debt loads and a lagging record on cost-cutting.

“Despite all this, the risk that the sovereign crisis will continue to spread looks high in the absence of quick and decisive action by the European authorities,” Kounis warned.

Bond market worries could quickly become self-fulfilling as rising bond yields made it harder to repay debt, he said.

If the European Union was called upon it could assist Portugal “without a cough or a shout,” said Howard Wheeldon, senior strategist at BCG Partners in London.

“But when and if it comes to a debt market implosion in Spain, EU ministers would find that they have a situation on their hands that may well be beyond their ability to resolve by agreement,” Wheeldon warned.

A report by Citi European Economics analysts said they believed a special regime eventually would be introduced in Ireland requiring private bank bond holders to take a “haircut” — market slang for accepting less than full repayment.

Eurozone finance ministers had made clear there would be no change in the rules for private holders of sovereign debt, it said.

“But, in our view, it now seems highly likely that the private sector will be involved from 2013 onwards,” Citi European Economics said.

“Hence, unless the fiscally strained euro area countries can convince markets that they will be on a sustainable fiscal path by 2013 — which looks unlikely to us — peripheral bond markets are likely to remain under strain, in particular Portugal,” the report added.

Moreover, because of uncertainties about whether a special regime in Ireland would later be introduced across the European Union, “market pressure on Spain might actually increase.”