Spain passes key loan test, but debt still rings alarms

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Spain got through a critical loan test on Thursday by offering higher interest rates but analysts said strong demand for the government bonds will reassure markets alarmed about the nation's finances.

The sale of long-term bonds was seen as vital to restore investor confidence in Spain, hit this week by rumours it needs huge rescue funds from the European Union and the International Monetary Fund.

It also came on the day EU leaders met in Brussels to discuss the European debt crisis and a day before IMF head Dominique Strauss-Kahn holds talks in Madrid with Spanish Prime Minister Jose Luis Rodriguez Zapatero.

The successful auction pushed the euro higher against the dollar Thursday while more positive news came from the IMF, which said it was "very impressed" with Madrid's measures to tackle the its fiscal crisis.

The Spanish treasury issued 3.0 billion euros in 10-year bonds and 479 million euros of 30-year bonds, raising 3.479 billion euros (4.305 billion dollars), the top end of its expectations of 2.5 billion to 3.5 billion.

Investors submitted bids worth 6.83 billion euros for the bonds.

Despite the strong demand, Spain had to offer higher interest rates than at the last similar auctions on May 20 and March 18, with investors increasingly concerned about the country's public finances.

The maximum yield for 10-year bonds was 4.911 percent, up from 4.074 percent, and 5.937 percent for 30-year bonds, compared to 4.768 percent previously.

The yields were slightly below market rates, adding to the positive comment on the outcome as many had expected the new debt paper to have cost the government even more.

"Overall, we are satisfied, the reactions of the market have been positive," a government spokesman said. "There has been a lot of demand, at a high rate but which is explained by the current situation in the markets."

"Spain has passed its test," said Cyril Regnat, a bond strategist at French investment bank Natixis.

Chiara Cremonesi, fixed income strategist at UniCredit Research, said "the auction went well, with Spain issuing close to the maximum of the range announced ... Another positive factor was that both bonds were sold at an average yield way below secondary market levels."

Sentiment has been affected by rumours concerning possible strains in the Spanish banking system and reports that Spain might need help amounting to 200-250 billion euros (246-307 billion dollars) from the European Union.

The EU, the IMF and the Spanish government all strongly denied the reports.

The speculation was fuelled on Wednesday when Strauss-Kahn announced he would meet Zapatero on Friday, although he stressed it was a "working" visit and again dismissed the reports of a Spanish rescue plan.

The Bank of Spain said meanwhile that it intended to publish "stress tests" on the ability of the banks to sustain sudden financial shocks so as to calm market nerves about the strength of its financial institutions.

Finance Minister Elena Salgado said the tests mean "the markets can verify that our financial sector is solid (and) ... recover confidence in us."

Spain's public deficit swelled to 11.2 percent of output last year and the Socialist government has launched an austerity drive to slash the gap between revenues and spending to the eurozone limit of three percent in 2013.

The government on Wednesday passed crucial reforms of the rigid job market, also deemed essential for reviving the economy and fending off a Greek-style debt crisis.

"We are very impressed by the deficit targets they have announced that seem fully appropriate," IMF spokesperson Caroline Atkinson said in Washington Thursday.

Government bonds are issued with a fixed annual return or interest, called the coupon, which does not change during the life of the bond.

As perceptions about the risk of the bond change, its price rises or falls, automatically changing the fixed cash return as a percentage of the new price.

Spanish bonds have fallen recently, pushing up the effective yield and this was reflected in the rate Madrid had to pay on the latest issue.

© 2010 AFP

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