Yields on 10-year Spanish bonds surged to a record high of almost 7.3pc as investors ignored the victory of pro-bailout parties in Greece's elections.
The closely-watched two-year yield rocketed by 65 basis points in a matter of hours, signalling a near-total collapse of confidence in Spain's €100bn (£80.3bn) rescue from the EU last week to shore up its banking system.
Bank of America said Spain may need a second rescue to tide it through the next three years, pushing the total loan package towards €450bn – a sum that would test the EU bail-out machinery and cause serious knock-on effects for Italy. A draft communique from the summit of G20 leaders in Mexico said Europe will take "all necessary measures" to hold the eurozone together and break the "feedback loop" between sovereign states and banks.
A separate text for next week's EU summit vowed to "mobilise all levers and instruments", though details were thin. Italy said it would push for a "semi-automatic mechanism" – probably involving the ECB – to cap the bond yields of states in trouble.
Bill Gross, head of the world's biggest bond fund Pimco, told Bloomberg TV that Spanish bonds were no longer a "safe environment" and warned that Germany itself had become a "credit risk" as the crisis metastasises. Spain's economy is twice the size of Greece, Portugal, and Ireland combined.
Spain's financial daily Cinco Dias said the bond rout had been a "massacre". The IBEX share index in Madrid fell 3pc and Italy's MIB dropped 2.8pc.
Angel Gurria, the head of the OECD club of rich states, predicted action from the ECB within a week, saying it was "high time" for leadership from Frankfurt. "We have run out of options. The Europeans have to display their awesome firepower," he said.
Mr Gurria urged the ECB to force down yields on Spanish and Italian bonds and deploy "every instrument, tool, and asset" in its arsenal, saying it would longer be enough to cut interests rates.
He warned that the crisis had been allowed to fester for so long that Spain and Italy may need soft debt-restructuring – perhaps by extending debt maturities – since public opinion in these nations will no longer tolerate ruinous debt service costs.
The ECB has not purchased any bonds for almost four months and continued to hold fire last week, but the mood is shifting within the governing council.
Austria's central bank governor Ewald Nowotny issued a thinly veiled rebuke to the ECB’s hawks yesterday, reminding them that deflation policies led to havoc in the 1930s.
“Due to misleading theories, a single-minded concentration on austerity led to mass unemployment, a breakdown of democratic systems and in the end to the catastrophe of Nazism. We must avoid the mistakes of the 1930s,” he said.
Spain’s woes are mounting relentlessly. Suki Mann from Societe Generale said the collapse of confidence has at last begun to infect blue-chip companies, with groups such as Iberdrola, Red Electrica, and Gas Natural facing a jump in borrowing costs of 30 to 50 basis points since Friday.
“Any resilience has been washed away. There are no buyers,” he said. Companies deemed rock-solid weeks ago risk a downgrade to junk status, with grim implications for the real economy. The blistering rally in corporate debt after the ECB’s €1 trillion lending blitz to banks has completely dissipated.
Spain’s central bank said that the ratio of bad debts had jumped to 8.7pc in April, a figure certain to rise if house price fall another 25pc as expected. El Confidencial reported that an outside bank audit had uncovered a shortfall of up €150bn, though not all of that sum has to be covered by fresh capital.
Spanish banks must repay or roll-over €540bn on the capital markets – mostly over the next three years – a burden that may fall heavily on the Spanish state if the economy fails to recover soon.
There has been fierce criticism of the EU for making matters worse by forcing lenders to raise core tier one capital ratios to 9pc by the end of this month, a move widely blamed for tipping the eurozone back into slump.
Telegraph
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