Spanish PM delays holiday as risk premium hits record

2nd August 2011, Comments 0 comments

Spain's debt risk premium soared to a record high Tuesday forcing the prime minister to delay his vacation so as to keep tabs on a growing economic emergency.

The premium demanded for buying Spanish 10-year bonds over safe-bet German bonds surged to more than four percentage points -- 404 basis points -- the highest since the introduction of the euro ihn 1999.

Prime Minister Jose Luis Rodriguez Zapatero "has postponed the start of his holidays; he is keeping an eye on the international economic situation," an official at the prime minister's office said.

Zapatero was in contact with his Finance Minister Elena Salgado's cabinet, his office said. Spain had contacted Britain, France, Germany and also Italy, where the debt risk premium hit a record high too.

Investors sold down Spanish and Italian bonds on concerns that their debt problems will only get worse as economic growth slows.

The eurozone debt crisis has already claimed Greece, Ireland and Portugal, forcing them to seek bailouts from the European Union and International Monetary Fund.

There are growing fears Italy and Spain could be next in line.

One trigger for the jump in the debt premium was a rumour in the market that Europe would release Italy and Spain from their obligation to take part in the European rescue of Greece, said Soledad Bueno, an analyst with Inversis.

"That gave the impression that they are not in a good situation," the analyst said.

Edward Hugh, an independent Barcelona-based economist, said Zapatero's decision last month to call a general election in November had already stirred up concerns about management of the crisis and fuelled doubts over Madrid's commitment to meet deficit-cutting goals in the run-up to the polls.

The rising risk premium means higher costs for Spain when it seeks to raise fresh funds to finance state spending.

It comes at a bad time for the government, which plans to raise 2.5-3.5 billion euros in a bond auction on Thursday.

But Hugh said the danger could be greater for Spanish banks, which use government bonds as collateral to get short-term financing on the London financial markets instead of running to the European Central Bank.

Many Spanish banks depended on London's LCH Clearnet clearing house for short-term financing, he said.

But once the risk premium on Spanish bonds reaches 450 points, the clearing house may issue a demand for an extra 15 percent margin from the banks, as it had done with both Portugal and Ireland, he said.

"What does that mean? It means that they have to post more collateral. Since they are already very, very, very stretched it becomes too much. What Spain cannot afford is for the spread to go to 450, which it will do."

If the risk premium reaches 450 basis points, Spanish banks could be forced to seek short-term financing from the European Central Bank which may not have the firepower to cope, Hugh said.

At that point, the European Financial Stability Facility, used in the Greek, Irish and Portuguese bailouts, may be asked to step in. "That is all maybe August, maximum September before we get there at this rate -- it could be next week."

© 2011 AFP

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