Spain's borrowing costs shot up at a bond auction on Thursday, after economic data confirmed the country is back in recession and reports that nationalised Bankia SA had suffered an outflow of deposits hammered its share price.
The Spanish Treasury had to pay around 5% to attract buyers of three- and four-year bonds. The longer-dated paper sold with a yield of 5.106%, way above the 3.374% the last time it was auctioned.
Spanish Prime Minister Mariano Rajoy warned on Wednesday that his government, struggling to reduce its budget deficit, could soon find it difficult to fund itself affordably on the bond market unless the pressure eases.
"This ... fits the pattern of recent sales, with the Spanish treasury successfully getting its supply away but at ever-higher yields," said Richard McGuire, rate strategist at Rabobank in London.
"This unfavourable trend looks set to remain firmly in place ... Ultimately, this ratcheting up of yields will likely require some form of outside intervention," McGuire said.
Spain's 10-year yields have spiked back above 6%, which investors view as a pivot point that could accelerate a climb to 7%, a cost of borrowing widely seen as unsustainable even though Madrid has sold well over half its debt needs for the year.
The premium investors pay for Spanish over German debt rose to its highest level since the euro's introduction this week, at over 500 basis points.
Top of the heavily indebted country's worry list is a banking sector beset by bad loans, the result of a property boom that bust in spectacular fashion.
El Mundo newspaper reported that customers at troubled Bankia had taken out more than 1 billion euros, equivalent to around 1% of the lender's retail and corporate deposits, over the past week in a sign of fast-fading faith in the lender.
The government took over Bankia, the country's fourth largest lender and which holds around 10% of Spanish deposits, last week in an attempt to dispel concerns over its ability to deal with losses related to the 2008 property crash.
The bank's shares plunged more than 20%, having shed 10% on Wednesday after it delayed publishing fourth-quarter results, stoking fears over the scale of losses it faces.
"The majority of outflows came after the chairman resigned last week, but I think once the bank was taken over by the government, depositors calmed down a bit," said one Madrid-based trader. "The share price fall has to do with disappointed retail investors dumping the stock."
The problem for Madrid is that property losses facing banks are not yet quantifiable, given prices are likely to fall further.
The government told the sector last week to set aside another 30 billion euros in provisions.
A government spokeswoman said the bidding process to select an external auditor to value real estate assets across the banking sector was still open, denying Oliver Wyman and BlackRock had been chosen as sources previously told Reuters.