Spain Feels The Heat As Borrowing Costs Rise

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As Spain's borrowing costs soar to unsustainable levels, fears mount for a full bailout which the eurozone can barely afford.

The return that investors now demand to hold Spanish 10-year bonds is at 7.6%, while the cost of insuring Madrid's debt against default has also hit record highs.

Madrid paid the second highest yield on short-term debt since the birth of the euro at an auction of three and six-month bills on July 24.

Spain has become the recent focus for investors as the country's increasingly desperate struggle to put its finances right has seen its borrowing costs soar to levels that are unsustainable.

This is highlighting growing concerns that Spain will need a full scale sovereign bailout, which would almost strip the eurozone of its cash reserves.

Spain has already asked for up to 100bn euro (£78bn) to recapitalise its banks, which have been battered by a four year economic downturn and a property crash.

The alarming spiral of Spain's debt costs has banished any hopes that a bailout of its banks, or a June EU summit that gave the eurozone's rescue funds a green light to intervene in the markets, has put the debt crisis into abeyance.

Spain has launched a fresh 65bn euro (£50bn) package of tax rises and spending cuts designed to chip away at its debt mountain but it will also probably drive the economy deeper into recession, which has been met with violent protests.

Meanwhile Greece, where the sovereign debt crisis began, also remains in focus. If Athens were to default or exit the eurozone, the knock-on effects could push Spain and even Italy over the edge.

EU Commission president Jose Manuel Barroso is meeting Greek Prime Minister Antonis Samaras to discuss the country's progress under its bailout plan.

Mr Barrosso's trip coincides with a visit by EU/IMF (Berlin: MXG1.BE - news) inspectors to assess whether Athens deserves to receive more payments under the 130bn euro (£101bn) rescue programme, as speculation mounts that it could be forced to quit the eurozone.

EU Commission spokesman Alejandro Ulzurrun said Mr Barroso last visited Athens in June 2009, and that since then there have been 13 inspections.

Mr Antonis Samaras said Greece's economy could contract by more than 7% this year, pushing debt-cutting targets further out of reach, but he pledged to stay the course.

Last week, the government said it expected the economy to remain in recession well into next year, while the autonomous region of Valencia became the first to ask Madrid for aid to pay debt obligations it cannot meet.

Spain and Italy have called for help to ward off market pressure. The European Central Bank has cut interest rates but has shown marked reluctance to revive its bond-buying programme, the only mechanism that could lower borrowing costs at a stroke.

:: Spanish markets reacted positively to a EFSF mechanism plan to buy debt directly, with Madrid's Ibex stock exchange showing gains of 0.82% at the close on Tuesday, after dips of more than 5% within the previous week.