May 30, 2012 / 12:42 AM / 5 years ago

European shares, euro hit by Spain's debt fears

LONDON (Reuters) - European shares slipped and the euro touched a 23-month low on Wednesday as investors worried that Spain’s banking problems would push its borrowing costs to unsustainable levels and after China signaled it is not planning a large stimulus package.

A man reacts while looking at information screens at the Madrid stock exchange May 29, 2012. REUTERS/Andrea Comas

Spain is expected to issue new bonds soon to fund its ailing banks and indebted regions despite its borrowing costs nearing the unsustainable 7 percent level that forced other euro zone countries to seek international aid.

“The bailout risks for Spain are increasing and that should keep the euro under pressure,” said Melinda Burgess, currency strategist, at RBS Global Banking.

The single currency dipped 0.3 percent to $1.2438 on Wednesday, its weakest rate since July 2010, and fell 0.7 percent against the safe haven yen to 98.755 yen.

The euro’s plight was also underpinning the dollar index, measured against a basket of major currencies, which rose above 82.66 to its highest since September 2010, dragging down dollar-sensitive commodities.

The drop in the euro came as 10-year Spanish government bond yields rose 7 basis points to 6.55 percent, and the cost of insuring against a Spanish default hit new highs.

The sell-off in Spanish bonds has also kept the risk premium or spread over safe-haven German government bond (Bunds) elevated at euro-era highs of 523 basis points.

“Spain issuing more bonds will not be liked by debt markets, in our view, suggesting that sovereign bond spreads will widen further against Bunds, keeping the euro on the back-foot,” said analysts at Morgan Stanley in a note to their clients.

German 10-year yields meanwhile hit fresh lows of 1.34 percent on Wednesday, while futures rallied to 144.62 before retreating slightly to stand 26 ticks higher on the day at 144.56.

An Italian government sale of up to 6.25 billion euros of five- and 10-year bonds later will be widely watched to see whether the worsening sentiment is spreading. The government’s borrowing costs are expected to rise at the auction but domestic investors should ensure sufficient demand.

CHINA HOPES DASHED

Major European company shares were moving lower on the Spanish bank jitters as well as disappointment over China.

The FTSE Eurofirst index of top European shares reversed all of Tuesday’s gains to be down 0.8 percent at 983.11 points and on track for its third straight month of losses.

World equity markets had been focused on hopes China would boost its flagging economy with new stimulus but these were dampened on Wednesday by reports in the domestic media.

An article published on the website of the official Xinhua news agency said China had no plan to repeat the powerful stimulus measures used during the global crisis in 2008. The story was in line with the view of Chinese policy advisers.

The reports undermined sentiment across Asian markets, and helped send the MSCI world equity index down 0.5 percent 302.31, while the MSCI emerging markets index was down 0.9 percent at 913.11.

The potential for slower global growth sent Brent crude down 74 cents to $105.94 per barrel and it is now on track for its biggest monthly decline in two years.

But the fall may be checked by oil supply concerns as Iran’s dispute with the West over Tehran’s nuclear program is unresolved.

“Iran continues to remain a significant factor but for the moment, with a short to medium term outlook the focus is on Europe and the demand side picture if the crisis continues to deteriorate,” Ric Spooner, chief market analyst at CMC Markets said.

Gold dipped to a one-week low tracking a weaker euro, falling as much as 0.6 percent to $1,544.74 an ounce. The precious metal is poised for a monthly loss of nearly 7 percent and a fourth month of decline.

Additional reporting by Anirban Nag; editing by Anna Willard

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