Spain and Italy pay the price for investors' jitters

Spain and Italy saw their borrowing costs spike again yesterday as investor fears intensified that those two nations could be knocked sideways by a sudden Greek exit from the single currency.

Madrid had to pay an interest rate of 4.373 per cent to raise three-year money at an auction, up from 2.89 per cent in April. The interest rate on newly issued four-year bonds hit 5.106 per cent, up from the 3.374 per cent Madrid paid in March.

The interest rate on Spanish 10-year bond yields rose, too, in trading, ending at 6.3 per cent, a level regarded as unsustainable. Meanwhile, Italian10-year borrowing costs rose above 6.06 per cent at one stage, before falling back to 5.97 per cent, as nerves about the ability of Europe's most indebted state to service its debts also increased.

Doubts about Spain's creditworthiness are growing because of the weakening domestic economy and rising uncertainty about the fate of Greece.

"Spain is selling its debt at punitive rates against a rapidly deteriorating domestic and external backdrop," said Nicholas Spiro, of Spiro Sovereign Strategy. "Eurozone 'break-up contagion' is seeping into Spanish yields."

If Greece crashes out of the single currency, imposing huge losses on creditors and bank depositors, many fear that investors will pull their money of other struggling eurozone states such as Spain and Italy, forcing those nations to seek a bailout from the European Union and the International Monetary Fund.

The largest purchasers of Spanish and Italian sovereign bonds in recent months have been the banks of those two countries. Italian banks are estimated to be holding €287bn in Italian sovereign bonds.

Spanish banks are believed to have €220bn in Spanish state debt on their books. But analysts suspect that one of the reasons bond yields have been rising – along with rising fears about the safety of those loans – is that these banks are running out of the capacity to buy them.