Italy's creeping crisis sends Spanish risk premium sky-high

The financial turmoil rocking Italy pushed Spain's risk premium - the reward investors demand to hold Spanish 10-year bonds over the benchmark German ones - up to 414 basis points on Wednesday, close to its historical high of 417 registered in early August. Italy's premium, meanwhile, soared to 574. Market behavior underscored the link between two economies that are perceived as too big and laboring under too much debt to be effectively bailed out by the euro zone's financial safety net. If either country requested a rescue package, it would have to be much more ambitious than anything contemplated to date by European leaders.

Although Spain had initially seemed like a bigger risk to international investors, since last summer it is Italy that has moved into the eye of the euro storm as a solvency crisis has blown up almost in slow-motion, with political moves toward any solution proving painfully hard going.

Spanish authorities have felt marginally relieved, although recent developments show that in both cases risk premiums have reached the levels that forced the European Central Bank to buy Spanish and Italian bonds massively in early August.

Italian and Spanish stock markets also led in losses, with Madrid's blue-chip Ibex 35 closing down 2.09 percent at 8,340.60 points.

Meanwhile, Tuesday evening's meeting of European finance ministers failed to produce a consensus on the implementation of a financial transaction tax. Although France, Germany and Spain firmly support it, Britain, Sweden and the Czech Republic are radically opposed.

Swedish Finance Minister Anders Borg said such a tax could end up increasing borrowing costs and deepening the debt crisis by reducing turnover on the secondary market for government bonds.

But Spanish Economy Minister Elena Salgado said that Spain is in favor of a 0.1-percent levy on transactions with shares and bonds and 0.001 percent for derivatives.

What those attending the Ecofin meeting did agree on, however, was a European norm to ensure that banks' recapitalization obligations do not result in a reduction of credit flows. "We want to ensure there is no sudden or massive deleveraging," said Internal Market Commissioner Michel Barnier about a temporary capital buffer of nine percent that will apply to 70 banks and need to be in place in June. Ministers are trying to prevent credit from drying up and thus helping to push the EU into another recession.

At the meeting, Salgado noted that Spain is already reducing imbalances such as the current account deficit, which is now below the four-percent limit, and "improving on competitiveness and productivity."

"We don't need a EU analysis to know that an excessive deficit puts our economy's health at risk," she noted.