Political scandal, economy cost Spain at bond auction

Spain's funding costs climbed at a bond auction on Thursday after a corruption scandal touching Prime Minister Mariano Rajoy's party and concerns over the country's weak economy tempered investor enthusiasm.

The costs remained far from crisis levels, however, and demand was solid.

The Treasury paid almost half a percentage point more for its shorter-dated debt at a triple bond sale from just four weeks ago. But at around 2.8 percent, two-year yields were a shadow of last summer's euro-era highs above 7 percent.

The auction also means Spain had sold 19 percent of its full-year medium- and long-term funding target, the economy ministry said.

"The result of today's auction reflects the recent shift in sentiment towards Spain - a marked increase in yields after months of declines," said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London.

But he said that Spain should be pleased by the results given the current economic and political problems.

Yields have jumped back up to mid-December levels in Spain and elsewhere in Europe, as an economic downturn spreads around the entire euro zone and recovery outside the region is boosting demand for high-yielding assets.

France's long-term bond yields also rose in their latest debt sale on Thursday, for example.

But Spain is also being scrutinized by investors for potential political instability because of a widening corruption scandal involving officials of Rajoy's People's Party.

A former party treasurer, Luis Barcenas, has described as fakes handwritten ledgers published last week by El Pais newspaper, which accused the party of channeling payments through secret accounts from managers of building companies to its leaders, including Rajoy.

Rajoy has also denied any wrongdoing. Barcenas appeared on Wednesday for questioning by prosecutors who are looking into reports.

ECONOMIC CONCERNS

A pledge by European Central Bank to buy debt of struggling euro zone states has helped create a firewall against a selloff of Spanish paper, but with the economy in a deep recession and growing concerns over its finances, it may sees debt costs rise again.

The country has been at the centre of the euro zone debt crisis as it fights to deflate one of the highest budget deficits in the bloc through wide-reaching austerity measures, which many claim could make economic recovery harder.

The government is expected to announce a public deficit of around 7 percent of gross domestic product in 2012 in the next few weeks, down from over 9 percent a year earlier.

However, many fear such a sharp reduction implies unprecedented budget cutting efforts that will be near impossible to continue.

Spain's budget plan faces strong headwinds from rising costs of 26 percent unemployment, an aging population and high debt funding bills.

On Thursday, Spain sold 1.948 billion euros in a 2015 bond, with the yield rising to 2.823 percent, up from 2.476 percent at the last sale of that paper, in January. Yields also rose on a 2018 bond and a 2029 bond that were sold at the auction.

In all, it sold 4.6 billion euros worth of the three bonds, slightly higher than the top end of its target range. Demand was strong, continuing the trend from January when Spain saw yields on shorter-term paper falling to 10-month lows.

Spain's Treasury will stage a roadshow next week, arranged by Citi and Deutsche Bank, for institutional investors in the United States, a source at the economy ministry said.

Non-resident participation in Spanish debt sales fell steadily through 2012, though rose to around 60 percent at a syndicated issue January 22 as foreign investors return to the country's bonds.

(Additional reporting by Carlos Ruano, William James in London; Editing by Fiona Ortiz/Jeremy Gaunt)