* Outspoken austerity critic reclaims Socialist party
* Spanish bond markets underperform euro zone peers
* Risk of political stalemate, new election rises (Adds quote, updates prices)
By John Geddie
LONDON, May 22 (Reuters) - Spanish government borrowing costs rose on Monday as one of the most outspoken critics of Mariano Rajoy’s conservative ruling party and its austerity policies returned to lead the opposition Socialists.
In a year when Austria, the Netherlands and France have fended off populist challenges at elections, political tension in Spain - where a minority government is in power - had fallen off euro zone investors’ radar.
But Pedro Sanchez’s re-election on Sunday as leader of the Spanish Socialist Workers’ Party (PSOE) served as a reminder of the government’s fragility in Spain.
Sanchez was ousted last year after refusing to abstain in a vote to help break a nine-month political deadlock and returns on a pledge to take a firm stance against the market-friendly, deficit-tackling policies of Rajoy’s People’s Party (PP).
“We expect the so far cooperative position of PSOE towards PP to shift significantly following Sanchez’s reappointment, raising the risk of snap elections,” Citi analysts said in a note, though they said this was not their base case.
The development will make it harder for Rajoy to secure the opposition support he needs to push through reforms, increasing the possibility of a hung parliament which he has warned would trigger a new national election.
Rajoy also faces a vote of no confidence in coming weeks, although the Socialists are not expected to move to topple the government at this time.
“The fact that the PSOE party members have voted for the candidate with the more left-wing agenda, should lessen the stability of the minority government,” DZ Bank strategist Christian Lenk said.
Spain’s 10-year government bond yield - an indication of the rate at which it can borrow cash in financial markets - rose as much as 5 basis points to a five-day high of 1.61 percent .
The political ructions also impacted Spanish stocks, which slid 0.6 percent at one point and were down 0.3 percent at the close.
All other euro zone equivalent bond yields were up 2-3 bps on the day, with the spread between Spanish and German yields at one stage stretched to its widest in nearly three weeks at 124 basis points.
A slew of corruption scandals have shaken the ruling People’s Party in recent years.
It was this that Spain’s anti-austerity party Podemos cited when they filed the no-confidence motion on Friday.
The motion will be voted on some time after Thursday.
Sanchez has said he will not support the motion and even if he did, the Socialists and Podemos together would not have the numbers to make it stick.
Fresh anxiety in financial markets around European politics also comes as Greece’s international lenders decide on the next steps in its long-running debt saga.
Euro zone finance ministers and the International Monetary Fund will seek a deal on Monday on debt relief that balances the IMF’s demand for a clear “when and how” with Germany’s preference for “only if necessary” and “details later”.
Without the deal, no new loans can be disbursed to Athens, which needs new credit to repay about 7.3 billion euros worth of maturing loans in July.
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Additional reporting by Paul Day in MADRID; Editing by John Stonestreet, Andrew Heavens and Pritha Sarkar