Paul Day and Jan Strupczewski Madrid and Luxembourg

SPAIN’S medium-term borrowing costs soared to euro era record levels at an auction yesterday, hours before an independent audit was due to reveal how big a capital hole in Spanish banks needs to be filled by a euro zone bailout.

Euro zone finance ministers were due to discuss later in the day how to channel up to e100 billion (R1 trillion) in rescue loans to Spanish banks weighed down by bad loans from a burst property bubble.

Spain’s financial weakness is in focus a week before an EU summit discusses plans for closer financial and banking union in an effort to strengthen the euro’s foundations. This follows the failure of bailouts for Greece, Ireland and Portugal to end a two-and-a-half-year sovereign debt crisis.

Madrid sold e2.2bn in medium-term bonds, with demand stronger than at last month’s auction, but yields on the five-year paper increased to a 15-year high of 6.07 percent, a level analysts regard as unaffordable for any prolonged period.

The runaway Spanish yields contrasted with a medium-term debt auction in France in which the yield on five-year benchmark paper hit an all-time low of 1.43 percent as investors sought the relative safety of a core euro zone country seen as backed by Germany.

“The first worry is: can they (Spain) fund from the markets? So they raised e2.2bn versus a e2bn target, so they can raise the money,” Lloyds strategist Achilleas Georgolopoulos said.

“Then (the question is), are the yields threatening for the medium term? And yes, clearly they are much higher than the previous auction, which was widely expected.”

Two independent auditors were due to deliver a report to the Spanish government late yesterday on the recapitalisation needs of the banking sector following last month’s nationalisation of lender Bankia.

Industry sources said yesterday that the report would say the banks needed to raise a further e60bn to e70bn.

However, a formal request for assistance may only come today when Prime Minister Mariano Rajoy meets German Chancellor Angela Merkel, French President François Hollande and Italian Prime Minister Mario Monti to discuss the future of the euro zone.

The finance ministers are also expected to discuss the next steps with Greece, following the formation of a coalition of mainstream parties committed to the country’s second e130bn EU/International Monetary Fund bailout. – Reuters