Troubled Spain, Portugal face pre-Easter debt test

MADRID/LISBON - Spanish borrowing costs are likely to jump at a bond auction on Wednesday as this week's tough budget fails to calm investors' nerves about the country's finances, while Portugal will sell its longest-dated debt since it took an international bailout.

In a double test of appetite for Iberian debt, the Spanish Treasury will sell up to 3.5 billion euros ($4.65 billion) in debt while neighbouring Portugal will offer 18-month T-bills for the first time since March 2011, a month before the European Union and International Monetary Fund staged the rescue.

Spain's offering is split between three medium-term bonds as it comes close to raising half its entire 2012 funding needs in just a little over three months this year.

The Treasury raced ahead of its issuance plans in the first quarter, taking advantage of the fact that banks are awash with cash after the European Central Bank lent almost a trillion euros of cheap 3-year money to avert a new euro zone credit crunch.

Wednesday's relatively small issuance will help markets to swallow the bonds before they break for the long Easter weekend.

While the ECB's huge cash injection will still support the Spanish auctions, borrowing costs have already risen on the secondary markets due to doubts about the government's ability to cut its deficit - even after Tuesday's austerity budget.

"The longer-term fiscal and economic challenge facing Spain remains great. However, we see no reason for this auction not to go well. The auction size is small and easily digestible," said Jamie Searle, strategist at Citi.

Spain is trying to assure the jittery markets and fellow European governments that it can slash the budget deficit this year, even as the economy slips into a recession that will make its job harder as tax revenues fall and social spending climbs.

Debt costs are set to rise on all three issues. Analysts expect the bond maturing on Jan. 31, 2015 to have an average yield around its current secondary market trading level, which was 3.1 percent late on Tuesday. That would be up from 2.440 percent on the same bond when it was issued just two weeks ago.

Similarly, the bond maturing on Oct. 31, 2016 is expected to have a yield of around 3.95 percent, around 60 basis points higher than its last sale on March 1.

The longer-dated Oct. 31, 2020 bond is forecast to have a yield around 5.2 percent. It was last sold in September, 2011.

But lower prices may well attract domestic banks to the issue, say analysts, and provide another support for auctions.

Not much risk

Portugal stopped issuing bonds when it agreed the 78-billion-euro bailout but has remained in the short-term debt market, regularly offering T-bills with maturities of up to 12 months. It will also offer 6-month T-bills on Wednesday.

The total indicative offer for both maturities in the auction was set at 1.25 billion to 1.5 billion euros.

Analysts expect a strong auction, continuing the trend seen in the past couple of months when yields fell steadily in such offerings, allowing Portugal to increase the amounts and lengthen the maturities of its T-bill issues.

"You don't debut with an 18-month issue without having made sure (about demand), so I don't see much risk," said Filipe Garcia, head of Informacao de Mercados Financeiros economic consultants in Porto.

Local banks were likely to buy most of the T-bills as they still had plenty of liquidity from the ECB's injections of ultra-cheap funds in December and February, he said, adding that he expected the yield on the longer maturity to be below 5 percent and probably closer to 4 percent.

The longest T-bill issued so far, of 12 months, yielded 3.652 percent in an auction last month, down from 4.943 percent in February and at the lowest level since late 2010.

But Garcia said that while the state was likely to sell the T-bills fairly easily, the economy was not getting adequate financing from the banks. "That's where the risk is," he added.

Most investors doubt that Portugal, which is in a deep recession, can finance itself fully in the commercial debt market from the second half of 2013 as the bailout deal envisages. They believe it will need additional rescue funds.

But the international lenders and government say the country is on track to meeting its bailout goals, including the return to the markets.

Some analysts and bankers say Portugal could make a partial return to the bond market in 2013 and then gradually increase maturities and amounts.

Portugal's benchmark 10-year bonds yield around 12 percent in the secondary market, up from last week's lows of nearly 11 percent, but way below 17 percent highs seen in January. ($1 = 0.7518 euros)

(Additional reporting by Daniel Alvarenga; editing by David Stamp)

Source: Reuters