Spain's borrowing costs jumped at a debt tender on Monday as concerns rose that Greece may restructure its debt, and the outcome of elections in Finland posed another potential obstacle to Portugal's rescue package.
The developments caused Spain and Portugal's risk premiums to climb while the European stock markets were also heavily hit, with losses widened by a threat by Standard & Poor's to lower the outlook on its US sovereign rating to negative.
The tender was held after the euro-skeptic True Finns party, which is opposed to European bailouts, made a surprisingly strong showing at Sunday's general election. The Finnish parliament has the right to vote on requests for European emergency funding.
The Greek government rejected speculation that it would seek to restructure its debt, but Reuters quoted German government sources as saying Greece is likely to do so before the end of summer.
"The auction took place at the worst possible moment," Reuters quoted IG Markets analyst Soledad Pellón as saying. "After a period of calm, tensions have returned to the debt markets because of Greece's problems, and doubts about the rescue process.
"Added to this is the anti-euro outcome of the Finnish parliamentary elections, and both factors have cooled demand for Spanish debt," she added.
The European Commission said Monday it expects Finland to continue to back the European Financial Stability Facility (EFSF). "We fully expect Finland to honor its commitments made in terms of participation of Finland like the rest of the euro zone in the EFSF," an EC spokeswoman said.
The Spanish Treasury said it issued a total of 4.65 billion euros in bills at the tender, compared with a target of up to 5.5 billion euros. It sold 3.5 billion euros in 12-month bills at a cut-off rate of 2.900 percent, up from 2.178 percent at the previous auction held on March 15. It sold a further 1.15 billion euros in 18-month bills, with the marginal rate climbing to 3.496 percent from 2.500 percent.
Yields had fallen at the previous five tenders held by the Treasury as Spain seemed to decouple itself from the problems of Greece, Ireland and Portugal.
Demand also fell, with the bid-to-cover ratio for the 12-month bill auction dropping to 1.63 times from 2.37 times last month, while for the 18-month issue it fell to 2.04 times from 3.51 times.
The yields on the sovereign debt of the so-called peripheral euro-zone countries, including Spain, also rose. After opening at around 200 basis points, Spain's risk premium had climbed at one point to above 230 basis points by mid-morning, a level last seen prior to Portugal calling for emergency funding. The premium, however, was still well below the euro-era maximum of 289 basis points reached during the Irish debt debacle.
The yield on the Portuguese benchmark 10-year government bond climbed above 10 percent for the first time in the euro era.
The euro also fell against the dollar, while the European stock markets were sharply lower. The Spanish blue-chip Ibex 35 shed 2.02 percent, the PSI-20 in the Lisbon Euronext exchange was down 2.35 percent, while the euro-zone blue-chip EURO STOXX 50 lost 2.44 percent.
Spain's auction was held as a team of officials from the International Monetary Fund, the European Central bank and the European Commission arrived in Lisbon for talks on the terms of Portugal's bailout, the size of which has been initially estimated at 80 billion euros.
Jürgen Kröger of the Commission, Poul Thomsen of the IMF and the ECB's Rasmus Rüffer were due to meet on Monday with Portuguese Finance Minister Fernando Teixeira dos Santos and the governor of the Bank of Portugal, Carlos Costa, on the bailout for the Iberian country.
The talks have been complicated by the fact Portugal faces general elections on June 5 in the wake of Prime Minister José Sócrates' resignation last month. The IMF and the EU insist on securing a cross-party agreement on the terms of the rescue.
The aim is to reach an accord before a meeting of European Union finance and economy ministers slated for May 17. Portugal faces heavy debt redemption and coupon payments in June.