Eurozone: downgraded and downcast

Spain’s 10-year bond yield reached a eurozone record of 6.988 per cent before retreating to 6.95 per cent at midday after Moody’s cut the country’s credit rating citing its weak economy and debt. The high interest rate means investors doubt Spain’s ability to repay its debts, so they are demanding a higher yield on bonds if they are risking their money.

“The markets are telling us that they’re unconvinced by the bank bailout and that the next step is that the government will have to concede, capitulate, and go for a sovereign loan,” James Stewart, head of macro research at AX Markets, said.

The unsustainably high interest rate is similar to levels that pushed Greece, Ireland and Portugal into IMF-EU bailouts, and puts Spain in bailout territory for the first time since the euro was formed in 1999.

European and IMF money has already been pledged to rescue Spain’s banks, but the government has so far avoided asking for a humiliating bailout. However it seems investors are not buying into Spain’s declared “victory” after the agreement to pump up to 100bn euros of EU taxpayer money into the banking sector.

In contrast UK bonds were over-subscribed, with a debt auction running until 2060 raising £1.5bn with a 3.2 per cent interest rate. Italy’s 10-year-yield was barely unchanged at 6.21 per cent at midday.

One in four people in Spain are now unemployed and there is no short-term solution to the crisis. Spain’s problems can be traced back to a late 1990s property bubble which saw prices tripled in eight years until the bubble burst in 2007.

The worst is yet to come

Moody’s downgraded Spain’s sovereign debt three notches from A3 to Baa3 last night, just one notch above junk status, and warned further downgrades were possible.

“Spain and Italy might not be Greece, but neither are they Germany,” Chris Beauchamp, market analyst at IG Index, said. “Everyone is rightly worried that both nations are headed towards bailouts.”

London’s FTSE, Germany’s DAX and France’s CAC all stumbled into the red after Moody’s news and the worst is not over yet for Europe. Greece heads to the polls on Sunday in a second attempt to elect a new government – a crucial vote. If the anti-austerity party Syriza is successful it could ultimately lead to Greece into leaving the euro.

Moody’s also lowered Cyprus’s bond rating to Ba3 from Ba1 as the country is likely to need funds to shore up its banks if not the entire economy.

Cyprus’ bloated civil service, exposure to its Greek neighbour and a property bubble have all contributed to financial trouble on the island of debt.