Spain borrows 2 billion euros but at a high cost

MADRID (Reuters) - Spain soothed fears on Thursday that it is being cut off from financial markets by raising more than 2 billion euros at a bond auction, although it had to pay dearly to borrow the funds.

The Treasury met strong demand for the relatively small sale of medium- and long-term bonds but yields on the debt were higher than at recent auctions, as Madrid negotiates with its European partners a rescue for its ailing banks.

The 10-year benchmark bonds yielded 6.044 percent, the highest at an auction since 1998 when Spain was still using the devaluation-prone peseta currency. However, analysts took heart from the fact that this was below the 6.14 percent where it was trading on the secondary market just before Thursday's auction.

"Spain can clearly still borrow in the markets but it must pay high yields for the privilege," said Lyn Graham-Taylor, rate strategist at Rabobank in London, adding that local banks had probably bought most of the bonds as international investors remain wary of Spanish government debt.

Earlier this week, the treasury minister rang alarm bells by saying the long-term interest rates the government was having to pay indicated markets were closing to Spain, now caught in the regional storm over debt levels in the euro zone.

On Wednesday, the economy minister said he had no immediate plan to follow Greece, Ireland and Portugal in asking for a European Union bailout.

But European sources said German and EU officials were urgently looking at how to pump cash into Spanish banks crippled by the collapse of a real estate bubble without forcing Madrid to submit its government finances to international strictures.

After Thursday's auction the Economy Ministry said Spain had now borrowed 58 percent of its gross needs for the year and was pleased with the yields it had to pay.

"We want to emphasise the strong demand which has confirmed the tone of the last auctions despite market jitters. This reflects the confidence in the Spanish paper," a ministry source told Reuters.

Altogether the strong demand enabled the Treasury to sell 638 million euros of a two-year bond, 825 million euros of a four-year bond and 611 million euros of the 10-year benchmark.

"By and large it is a good auction and it is another step towards normalisation of the Spanish funding condition," said Sergio Capaldi, fixed income strategist at Intesa Sanpaolo in Milan.

SPANISH BANKS

The Treasury needs to keep borrowing costs from rising out of control as it has to refinance 82 billion euros of debt this year, while helping its indebted autonomous regions repay maturing debts on their accounts of about 16 billion euros in the second half of 2012.

By contrast, France's borrowing costs fell to record lows at auction on Thursday, with investor appetite soaring for the country's relatively safe-haven bonds amid the worries over Spanish debt that have rattled peripheral markets.

The bid-to-cover ratios were higher than at recent auctions, with the 2012, 2014 and 2022 bonds covered 4.3, 2.6 and 3.3 times respectively, which analysts said was a sign of continued support to the sovereign from domestic banks.

"A strong set of bid/covers, as was expected, probably driven by domestics," said Graham-Taylor.

Spanish banks were able to scoop up large amounts of debt early this year after using the ECB's three-year cheap funding operations.

Spanish lenders held 146.26 billion euros of sovereign debt in April, 30 percent of the total of government bonds in circulation, up from 13 percent in the same month a year ago while non-resident holdings of bonds dropped to 38 percent, down from 54 percent last April, data from the Bank of Spain showed.

Support could now well fade if funding costs, driven higher by concerns over undeclared property losses on banks' books, do not come down in the next few weeks and as the government and European policymakers race to cut the link between the banks and the sovereign creditor.

(Editing by Fiona Ortiz and David Stamp)