Beleaguered Spain was handed a lifeline by the European Commission (EC) yesterday as the nation was given an extra year to slash its deficit.
The relief for Spain – in the grip of a double-dip recession and record unemployment of 5.64 million – came as fears over its struggling banks pushed Madrid's borrowing costs up to 6.67 per cent, the highest since the country joined the euro.
The latest panic sent investors running for cover across Europe as Italy took a fresh hammering in bond markets and the euro plunged to a new two-year low of $1.2407.
Under the terms of the fiscal pact, Spain is obliged to cut its deficit to 3 per cent in 2013, forcing a brutal €27bn (£21.5bn) in budget cuts from Prime Minister Mariano Rajoy's centre-right administration. But these targets are widely seen as optimistic given Spain's economic woes.
The EC's economic and monetary affairs commissioner, Olli Rehn, said Spain would be given an extra year to meet the target, subject to controls on spending.
Mr Rehn said: "We are ready to consider proposing an extension of the deadline to correct the deficit."
The relaxation of deficit targets came amid fresh concerns over Spain's banks as the European Central Bank (ECB) insisted that it was up to individual nations to strengthen bank balance sheets.
"The funds needed to ensure banks' compliance with capital requirements cannot be provided by the eurosystem," the ECB said.
The rare intervention from the ECB scotched reports that Spain was planning to recapitalise its fourth-biggest bank, Bankia, with government bonds.
Spain's banks – laden with €184bn in struggling property loans – have taken centre-stage in the crisis, although the threat of a Greek pullout of the euro is still hanging over the markets ahead of elections on 17 June.
Spain's stock market crashed 1.9 per cent to nine-year lows in a torrid day which saw France's CAC40 slide 1.7 per cent and Germany's Dax fall by 1.4 per cent.