Spain bond demand stays high, economy shrinks

MADRID Thu Feb 16, 2012 2:14pm GMT

A Spanish flag flies in Madrid's Plaza Colon February 15, 2012. REUTERS/Paul Hanna

A Spanish flag flies in Madrid's Plaza Colon February 15, 2012.

Credit: Reuters/Paul Hanna

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MADRID (Reuters) - Spain drew solid demand for its debt on Thursday, easily shifting what it wanted to sell at a bond auction, although concerns about Greece's second bailout and the fragility of some of the euro zone's riskier economies pushed financing costs higher.

An auction in France also attracted good support, leaving two-year yields below 1 percent, showing investors continue to favour the stronger north.

Underlining problems in Spain, data on Thursday showed its economy - which is facing even more austerity - contracted in the fourth quarter for the first time in two years. By contrast, France earlier in the week reported higher-than-expected growth.

While demand at the Spanish auction was high, the average yield on a three-year offering jumped more than 47 basis points from its last outing just two weeks earlier.

"There's pressure on the prime minister to enact more austerity, especially considering their target for this year. What with the effects of austerity and ambitious deficit targets, it's just a reflection of the general fear that's in the market," strategist at 4Cast Jo Tomkins said.

The premium investors demand to hold Spanish over German debt rose to around 381 basis points, around 25 basis points from the close on Wednesday, after euro zone finance ministers failed to agree on a second aid package for Greece.

"We've seen the Treasury hit the maximum target for its bonds, with strong demand, which is a sign of confidence in the Spanish economy and the measures that are being taken," said Economy Minister Luis de Guindos in Parliament on Thursday.

The economic picture, however, was grim.

Gross domestic product shrank by 0.3 percent in the fourth quarter on a quarterly basis after stagnating in the third quarter, final official data showed, as an economic slump which began almost five years ago dragged on.

In 2011, the economy grew by 0.7 percent compared with a fall of 0.1 percent in 2010.

The economy would be a "little worse" in the first quarter of 2012 than the last three months of last year, Economy Secretary Fernando Jimenez Latorre said on Thursday, confirming expectations that Spain is already in recession.

Spain had been growing at an above-average rate since the country entered the euro monetary union 12 years ago, but the boom was largely due to a housing boom fuelled by cheap loans and the economy has struggled since the 2007 crash.

In the fourth quarter, exports were the only sector to show growth with industry surviving solely because of demand outside of Spain, though even that is slowing as the economies of the country's main trading partners stumble.

Meanwhile, Spain's new government is fighting to reduce a budget deficit it has estimated at 8 percent of GDP in 2011 to a target of 4.4 percent this year, implying necessary savings of an estimated around 45 billion euros (37.3 billion pounds).

"The short-term economic outlook remains very challenging ... We expect the recession to linger throughout 2012 following by lacklustre recovery in 2013, implying the economy could contract for two successive years," economist at Global Insight Raj Badiani said.

The government, confronted with an imminent recession, the highest unemployment rate in the developed world and a banking sector reeling from the collapsed property market, has passed three key economic reforms since taking power in December.

On Thursday, the conservative-dominated Parliament passed financial sector reforms which force its banks to raise capital levels and revalue property and land on their books.

STRONG DEMAND, HIGH PRICE

Spain easily sold 4.1 billion euros of three bonds, just above the targeted range but with some pressure on yields as support from cheap cash from the European Central Bank waned.

The Treasury has front-loaded its debt issuance this year, issuing over 34 percent of the whole year's target, taking advantage of liquidity rich banks which have taken massive levels of cheap loans from the ECB.

The ECB's long-term refinancing operations (LTRO) flooded markets with almost a half a trillion euros of cheap three-year cash in December and will provide more of the same at the end of this month.

Spanish lenders borrowed record sums from the central bank in January to buy higher yielding sovereign bonds and make inroads into looming debt mountains of their own.

"The market is clearly price sensitive now, as shown by the quite large tails. This is good funding progress for Spain but in the very short term there may be some cheapening as the market absorbs the paper," rate strategist at Credit Agricole, Peter Chatwell said.

Spain sold 2.3 billion euros of a bond maturing July. 30, 2015 at an average yield of 3.322 percent compared with 2.861 percent paid at the last primary auction on February 2.

The bond was 2.2 times subscribed, compared with 1.6 times earlier in the month.

The Treasury shifted 733 million euros of the other 2015 issue, maturing January 31, at an average yield of 2.966 percent and a bid-to-cover ratio of 4.4, and 1.1 billion euros of a bond maturing October 31, 2019 with a 4.832 percent yield and 3.3 times subscribed.

"The Spanish Treasury's strategy for issuance this year looks shrewder with each passing day. For the time being the effects of the LTRO are suppressing Spain's deteriorating fundamentals," economist at Spiro Sovereign Strategy, Nicholas Spiro said.

"Developments in the bond market and the real economy are increasingly at odds with each other."

($1 = 0.7654 euros)

(Additional reporting by Robert Hetz; Editing by Jeremy Gaunt/Ruth Pitchford)

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