Spanish auction disappoints, as ECB keeps rates on hold

Bond investors delivered a blow to the Spanish government yesterday as they shunned Madrid's first debt auction since the austerity budget unveiled by the centre-right administration of Mariano Rajoy last week.

Spain managed to offload €2.6bn in bonds with maturities of between three years and eight years. The debt placed was towards the bottom end of Madrid's €2.5bn to €3.5bn target range. The interest rate the Spanish government was required to pay to offload the debt also rose to 5.3 per cent, in a sign that investors are demanding a high premium to compensate them for default risk.

In the wake of the disappointing Spanish auction, Mario Draghi, the president of the European Central Bank, announced that it is too soon to discuss winding down monetary support for the eurozone. "Any exit strategy talk for the time being is premature" he said at the ECB's monthly press conference in Frankfurt. The central bank has injected close to €1 trillion into the European banking system since December, a move that has caused the borrowing rates of vulnerable eurozone member states such as Spain and Italy to fall sharply.

The ECB president refused to comment specifically on the Spanish auction, but he did argue that the recent uptick in Italian and Spanish bond yields is a signal from investors that governments in Rome and Madrid need to push ahead with their promised austerity measures and labour market reforms. "I would regard recent developments not as a sign of fragility, but as a sign that markets are expecting reforms. Markets are asking governments to deliver" he said. The ECB kept its main policy interest rate on hold yesterday at 1 per cent, where it has been since December.

Last week the Spanish government unveiled a package of €27bn in spending cuts and tax rises for 2012, the most ambitious in its modern history. Mr Rajoy has been set a target by the European Commission of reducing Spain's budget deficit to 5.3 per cent of GDP this year, down from its present level of 8.5 per cent. Some investors have voiced concern that the cuts will worsen exacerbate the plight of the Spanish economy, which is expected to contract by 1.7 per cent this year.

"Spain is losing the confidence of the markets because the markets increasingly doubt whether brutal austerity is the answer to what ails Spain's economy" said Nicholas Spiro Spiro Sovereign Strategy.