Spain's borrowing costs shattered euro-era records on Thursday after Moody's downgraded its debt close to junk-bond status and warned of a growing risk of a full-blown bailout.
A weekend deal for eurozone powers to extend a bailout loan of up to 100 billion euros ($125 billion) to salvage Spain's stricken banks failed stop an intensifying storm on the debt market.
Instead, the sheer size of the rescue loan fed fears about its impact on Spain's mushrooming sovereign debt and prompted concerns that the state may eventually need rescuing itself.
The Spanish crisis is unfolding against the background of Sunday's Greek elections, further destabilising markets that fear a victory by anti-austerity parties could send Athens back to the drachma.
The interest rate on Spanish 10-year government bonds soared to 6.9650 percent, the highest since the birth of the single currency in 1999, from 6.721 percent the previous evening.
The difference in the rate between Spanish and safe-haven German 10-year bonds breached 5.50 percentage points, another euro-era record.
Such high interest rates are regarded by many analysts as impossible for the nation to afford to finance its activities over the longer term, raising the risk of a bigger bailout, just as was the case for Greece, Ireland and neighbour Portugal.
Moody Investors Service slashed Spain's sovereign debt rating by three notches late Wednesday to Baa3 and left it on review for a possible further downgrade.
Since many institutional investors are barred from buying bonds that are rated as junk, or non-investment grade, the prospect of a further downgrade sent a further chill through the market.
“The risk of losing investment grade pressured the differential this morning and left it at historic highs,” analysts at Spanish brokerage Renta 4 said in a market report.
Spain's government insists the eurozone rescue loan, destined to recapitalise banks whose books are heavily exposed to a 2008
property market crash, will be repaid by those lenders who receive the money.
But the final responsibility for repaying the eurozone is clearly Spain's, Moody's said.
“This will further increase the country's debt burden, which has risen dramatically since the onset of the financial crisis,” the agency said in a statement.
It predicted Spain's public debt, which amounted to 68.5 percent of economic output at the end of 2011, would bulge to 90 percent this year and carry on rising until the middle of the decade.
At such high borrowing rates Madrid had limited access to the markets, as demonstrated by the fact that it was forced to seek a rescue loan, the agency said.
Further, the country was increasingly dependent on commercial banks, flush with cheap loans provided the European Central Bank, to buy its government bonds, the agency said.
“In Moody's view this is an unsustainable situation.”
Unless there were signs of a quick improvement in Spain, such as an exit from recession or rapid progress in cutting the deficit, “neither of which is likely,” the agency warned that Spain would be increasingly constrained in refinancing maturing debt.
If unchecked, Moody's said Spain could lose affordable access to the debt markets and face a rising risk of a full-blown state bailout by the European Financial Stability Facility and/or the new European Stability Mechanism, which comes into force next month.
“Moody's action to place the government's rating one notch above speculative grade reflects the rating agency's view that Spain has moved much closer to needing to seek direct support from the EFSF/ESM, and therefore much closer to being positioned within speculative grade,” it said.
If the Spanish state requires a rescue private investors could be burned, as they were in Greece, the agency said.
In a further sign of tension, data Thursday showed Spanish banks boosted borrowing from the European Central Bank to a record 287.8 billion euros in May from 263.5 billion euros in April as they struggled to find affordable liquidity on a tight interbank market.
The ECB pumped more than 1.0 trillion euros in cheap loans into the European banking system in two operations in December and February, seeking to avert a dangerous credit squeeze. - Sapa-AFP