Spain's bonds slumped, with 10-year yields rising to a euro-erarecord, after Moody's Investors Service cut the nation's creditrating to one step above junk, citing its rising debt burden andweakening economy.

Italy's 10-year yield reached the highest level in almost fivemonths after its borrowing costs surged at a sale of 4.5 billioneuros ($5.65 billion) of three-, seven- and eight-year notes.Spanish 10-year bonds have dropped all four days this week afterthe nation requested as much as 100 billion euros of aid for itsbanks last weekend. German bunds gained.

The “markets are telling us that they're unconvinced by the bankbailout and that the next step is that the government will have toconcede, capitulate, and go for a sovereign loan,” James Stewart,head of macro research at AX Markets in London, said in aninterview with Mark Barton on Bloomberg Television's “Countdown.”“That seems to me quite likely, and even now I think it's moving onfrom Spain to Italy.”

Spain's 10-year yield climbed 20 basis points, or 0.2 percentagepoint, to 6.95 percent at 1:27 p.m. London time after rising to6.998 percent, the highest since the euro was introduced in 1999.The 5.85 percent bond due in January 2022 fell 1.305, or 13.05euros per 1,000-euro face amount, to 92.405. The yield has jumped74 basis points this week

Italy's 10-year yield was little changed at 6.21 percent afteradvancing to 6.34 percent, the most since Jan. 20.

Moody's lowered Spain's credit rating to Baa3 from A3 and put iton review for a further downgrade. The request for aid from theEuropean Union to recapitalize its banking system adds to thegovernment's debt load, it said yesterday.

The company also lowered Cyprus's bond rating to Ba3 from Ba1,saying there was a material increase in the likelihood of a Greekexit from the euro area, and a rise in the probable amount ofsupport the government may have to extend to Cypriot banks.

Greece will hold an election on June 17 that may lead to itbecoming the first nation to exit the 17-nation currency union.

The extra yield investors demand to hold Spanish 10-year bondsinstead of similar-maturity bunds widened 23 basis points to 549basis points after reaching 551 basis points, also a euro-erarecord. Italy's 10-year spread over Germany expanded three basispoints to 476 basis points from as narrow as 276 basis points onMarch 16.

German 10-year yields fell two basis points to 1.47 percent.They dropped to a record 1.127 percent on June 1.

Spanish Borrowings

Spanish lenders' net average borrowings from the EuropeanCentral Bank rose to a record 287.8 billion euros in May from 263.5billion euros in April, Bank of Spain data showed today.

While a 10-year yield of seven percent “is a psychologicallysignificant level for the market, it isn't necessarily for Spain'sfunding program,” Lyn Graham-Taylor, a fixed-income strategist atRabobank International in London, said in an interview with GuyJohnson on Bloomberg Television's “The Pulse.” “It only reinforcesa further selloff when people see a 7 percent level.”

Italy sold 3 billion euros of three-year notes at an averageyield of 5.30 percent, up from 3.91 percent at the previous auctionon May 14. Investors bid for 1.59 times the amount allotted, versus1.52 times last month. The nation sold 4.5 billion euros of debt intotal, meeting its maximum target.

“The trend in yields and spreads is something which requiressomething from the policy-maker level to reverse,” said PeterChatwell, a fixed-income strategist at Credit Agricole Corporate& Investment Bank in London.

Italian Prime Minister Mario Monti yesterday called on Europeanallies to do more to foster growth as a way to end the debt crisisand said his government would soon outline new measures aimed atspurring the economy.

The trend in Italy's government bond futures is “bearish whilethey trade below the 99.32 mid-point” of their decline from 102.21on June 7 and the low of 96.43 on June 12, Richard Adcock, head offixed-income technical strategy in London at UBS AG in London,wrote in a note to clients. “As long as this remains the case theexpectation is for limited bounces and further price weakness.”

The contracts were little changed at 97.13 after dropping asmuch as 0.9 percent to 96.21.

Spanish bonds have handed investors a loss of 5.6 percent thisyear, according to indexes compiled by Bloomberg and the EuropeanFederation of Financial Analysts Societies. German debt returned2.5 percent, and Italian bonds rose 5.4 percent.

Volatility of French bonds was the highest in the euro-areamarkets today followed by Spain and Ireland, according to measuresof 10-year debt, the spread between two- and 10-year securities andcredit-default swaps.

Bloomberg News

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