Pressure grows on Spain to opt for a bailout from ECB

Pressure continues to mount on Spain's Prime Minister, Mariano Rajoy, to request a bailout from the European Central Bank as the country strained to sell €4bn (£3.2bn) of debt.

Although the latest auction of Spanish two-, three- and five-year bonds was subscribed, the cost of borrowing rose again. The average cost of borrowing for three years rose from 3.83 per cent to 3.96 per cent.

Its two-year bond yields have also risen sharply in recent days. This is a result of Spain in effect playing a game of chicken with bond markets ever since the ECB last month unveiled a scheme to buy the bonds of eurozone members that requested it, provided tough conditions were met.

Michael Hewson, CMC Markets analyst, said: "People expect Spain to ask for a bailout, so they buy the bonds and push the yields on the debt lower. But the more they buy the bonds, the more Rajoy thinks Spain might be able to get away with it and is less likely to ask for a bailout."

The bailout plan is limited in its scope as it only covers short-term government debt on the secondary or resale market. Senior EU insiders are still worried that it may be necessary to buy Spanish government debt at source, from the primary market, particularly if borrowing costs continue to rise. However, this could soon drain the resources of the eurozone's rescue fund, the ESM.

Therefore, after a meeting between the Finnish Prime Minister, Jyrki Katainen, and the French President, François Hollande, the idea is to potentially offer investors in new Spanish government debt an EU-backed insurance policy that would pay out in case of default.

"We're talking of no more than €50bn," said a senior source. "Under this scheme, the states would pose the conditions and make sure they're met, and the ECB would supply the firepower."

Christian Schulz, Berenberg economist, said such an insurance scheme could shore up bond market confidence: "With the ECB as a back-up, credit insurance could drive down Spanish borrowing costs further, particularly at the longer end of the maturity range."

Confidence in Spain was also hit by its own central bank governor casting doubt on its budget plans. Luis Maria Linde said Spain would have to consider further tax rises to hit targets.