SPAIN’S BORROWING costs rose above 5.5 per cent for the first time since January as investors fretted about another escalation of the euro zone crisis amid signs of further economic weakening even in Germany.

Investors, already nervous about Madrid’s deficit and weak growth prospects, pushed Spain’s benchmark 10-year bond yields up 14 basis points (bp) to as high as 5.53 per cent. Italy’s borrowing costs also rose with the yield on its 10-year bond breaking through 5 per cent.

Markets have been calmed in recent weeks by the European Central Bank’s cheap loans for lenders, known as the longer-term refinancing operation. But investors are becoming nervous that the impact of the two LTROs is wearing off.

Marc Chandler, currency strategist at Brown Brothers Harriman, noted that Italian 10-year yields have fallen 180bp so far this year while Spain’s have risen 39bp. “That is after two LTROs,” he said. “That definitely concerns me. When the bonds rally it helps the banks’ balance sheets. But when yields start rising it hurts the banks even more. It is a vicious circle.”

The economic fates of Spain and Italy are viewed as central to assessing whether the euro zone debt crisis – quiet since Greece’s default this month – could re-erupt. Investors worry that weak growth, not just in Italy and Spain but across the rest of the euro zone, could be the spark to reignite the crisis.

Euro zone purchasing managers’ indices, released yesterday for March, suggest weakening growth prospects across the continent, with an unexpectedly strong decline in Germany.

Investors have started to focus on Spain again this year after its budget deficit overshot targets last year and the government proposed to cut it less than it had agreed with European authorities for 2012. – (Copyright The Financial Times Limited 2012)