Panicking investors sent Spain's cost of borrowing above 6 per cent yesterday, pushing the country closer towards a bailout.
The yield on 10-year Spanish bonds rose to 6.15 per cent in trading yesterday morning as the country's Finance Minister, Luis de Guindos, confirmed that the economy contracted again in the first quarter of 2012.
The 6 per cent threshold is regarded as key for investors because when Greek, Irish and Portuguese bond yields breached this level their borrowing costs rapidly escalated, ultimately forcing their governments to seek external support from the eurozone and the International Monetary Fund.
In another sign of evaporating investor confidence in Spain, the price of insuring Spanish debt hit an all-time high yesterday.
Five-year credit default swaps on Spanish debt rose to 520 basis points, according to the data monitor Markit. This means it costs €520,000 (£430,000) annually to buy €10m of protection against a Spanish default using a five-year insurance contract.
Madrid will face another potentially difficult market test today when it attempts to auction up to €3bn in short-term bonds. The government is also due to try to sell a further €2.5bn in longer-term debt on Thursday.
Mr de Guindos told El Mundo newspaper that the economy probably shrank by 0.3 per cent between January and March, although he added that this was better than he expected two months ago.
Spain is seeking to slash its budget deficit down from 8.5 per cent of GDP to 5.3 per cent by the end of the year, and further to 3 per cent in 2013. To this end, the centre-right government has laid out a fiscal consolidation of €27bn over 2012. But an increasing number of analysts fear that public cuts on this scale will merely make the recession in Spain worse.