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Spain set to test market appetite for new 5-year bond

Source: Reuters - Thu 1st Sep 2011

Spain will follow Italy back into the bond market on Thursday, aiming to sell up to 4 billion euros of a new 5-year bond with recent sovereign debt purchases from the ECB expected to support prices.

The auction of the new benchmark paper will be the first bond sale for Spain in nearly a month. In that time the country has seen its borrowing costs soar to euro era highs, and then fall significantly as the ECB stepped in to buy the bonds of weaker states and stop the debt crisis spreading.

The support of the ECB will likely keep yields on the bond at lower levels than could have been expected, but borrowing costs still remain high for Spain.

Italy returned to markets on Tuesday, but its sale of nearly 8 billion euros of bonds drew weaker demand than expected and raised doubts over the sustainability of the country's funding efforts.

Spain's treasury is targeting a smaller 3 billion to 4 billion euros.

"The key will be for Spain to show it still has access to bond markets. So for that reason the simple amount raised will be an indication of how it goes, and I would expect the Treasury to sell close to the 4 billion mark," said David Schnautz, London-based strategist at Commerzbank.

The ECB has bought around 43 billion euros worth of debt since it reactivated its bond-buying program, helping to lower financing costs of struggling euro zone states.

The yield on the 5-year bond in Thursday's auction is likely to be roughly in line with a different 5-year bond, which was trading around 4.25% in the secondary market late Wednesday.

Yields on Spain's key 10-year debt rose above 6% in August, but have since fallen back to around 5%.

Analysts believe Spain could not afford borrowing costs of more than 7% over a long period without eventually being forced to take a bailout like Greece or Portugal.

Spain has scrambled to pass new austerity measures in the last two weeks to help meet its tough public deficit cutting target this year, while it also plans to include a deficit capping measure in its constitution.

However, market volatility and a lack of final agreement over Greece's second bailout package and an extension of the European Financial Stability Facility (EFSF) will keep markets nervous for some time.

Indeed Schnautz said he recommended being underweight periphery debt for now while countries such as Italy and Spain still had to issue sizeable amounts of debt before year-end.

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