The UK's cost of borrowing plunged to an all-time low yesterday as panicking investors sought safe havens from the financial firestorm engulfing Spain.
Investors piled into UK gilts as the embattled eurozone member's economic woes deepened and markets panicked over the latest threat to Madrid's creaking finances from struggling regional governments.
Global stock markets tumbled as Spain's cost of borrowing hit a euro-era high of 7.44 per cent – well into the territory which forced Greece, Ireland and Portugal to seek a bailout from the European Union and International Monetary Fund.
In contrast, the UK's cost of borrowing hit a record low 1.4 per cent – well below the current 2.4 per cent rate of inflation – as nervous dealers shunned returns on their cash and simply looked for shelter from the latest storm.
German bunds were in even greater demand as the eurozone powerhouse's benchmark, 10-year borrowing costs sank to 1.15 per cent.
Lloyds Bank Corporate Markets bond analyst Eric Wand said UK gilts had been bolstered in recent days by the prospect of another rate cut from the Bank of England, depending on the success of its Funding for Lending scheme to boost corporate credit.
But he added: "I'd say 70 per cent of what we're seeing is all about Spain and the safe-haven effect. Spain has been trying to get around their funding issues by issuing shorter-term debt this year, but the really worrying thing for them is they're paying so much for it. That can't continue in the medium term. If we carry on like this, it's going to get very messy."
Spain's economy minister, Luis de Guindos, is due in Berlin today for talks with the finance minister Wolfgang Schäuble, fuelling speculation the country is on the way to a full-scale bailout. Spain's stock market crashed more than 4 per cent at one point on a turbulent day for global markets which saw the FTSE 100 close down more than 2 per cent at 5,533.9.
The sell-off in Madrid reached such a pitch that Spain's market watchdog stepped in to ban investors from short-selling. This is where investors borrow stock to sell in the hope of buying it back more cheaply, and banking the difference as profit.
The euro also took a battering as the dollar hit a two-year high of $1.2140 against the single currency.
Spain has already been forced to seek a €100bn (£78bn) bailout for its banks, which have been laid low by disastrous property loans in the boom years. But the latest crisis comes from its regional governments as Murcia looked set to follow Valencia in seeking central government assistance. Spain's regions have been virtually shut out of debt markets and Madrid has been forced to set up an €18bn rescue fund to prop up their finances.
The Bank of Spain piled on the misery as its latest estimates showed a deepening recession for Spain between April and June as the economy shrank by 0.4 per cent. The pain is set to worsen as the prime minister Mariano Rajoy readies an extra €65bn in budget cuts to bring down the deficit in an economy with a jobless rate of 24.6 per cent.
Vincent Forest, an economist at the Economist Intelligence Unit, said: "The economic contraction is now accelerating and will have a significant negative impact on public revenue. In addition, social unrest has begun gathering pace over the past weeks, and could escalate further when the austerity measures begin to bite."
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