April 5, 2012 / 2:02 PM / 5 years ago

MONEY MARKETS-Spanish bank CDS jumps as contagion risks spread

* CDS on debt from Santander, BBVA jump over past month

* Spanish sovereign CDS also rises on fiscal concerns

* ECB exit strategy seen a way off

By Ana Nicolaci da Costa

LONDON, April 5 (Reuters) - The cost of insuring debt issued by Spanish banks against default has risen sharply over the past month, as a tough budget this week did little to soothe concerns over the country's deteriorating fiscal situation.

Default insurance for Santander is up 52 percent since March 1 to 393 basis points and the equivalent for BBVA jumped 54 percent over the same period.

Both Spanish banks underperformed the Markit iTraxx senior financials index - which measures Europe's financial institutions' insurance, or credit default swap prices. It rose by 20 percent over the same period.

Markit analyst Gavan Nolan said s lot of the moved was caused by the European Central Bank's low-interest, three-year loan programmes, or LTROs, that have pumped money into the banking system.

"They've actually tightened the relationship between the banks and the sovereign. So the banks have been buying sovereign debt and that has made their fortunes even more intertwined than they have previously," he said.

Pressure on Spanish government debt has had a knock-on effect on banks.

Yields on 10-year Spanish bonds this week rose to their highest since December 2011 at 5.8 percent after the Spanish Treasury had to pay more dearly to borrow in an auction.

The cost of insuring Spanish sovereign debt against default meanwhile has jumped 111 basis points to 467 bps over the past month, according to Markit data. This means it costs $467,000 annually to buy $10 million of protection against a Spanish default using a five-year CDS contract.

Spain' tough budget this week has not been enough to calm investor nerves and many fear too much austerity could choke an already struggling economy where unemployment rose to a staggering 22.9 percent in the fourth quarter of 2011 - the highest in the European Union.

NO EXIT

After keeping interest rates steady at 1.0 percent on Wednesday, European Central Bank President Mario Draghi said it was premature for the bank to start planning a retreat from emergency crisis-fighting and that the ECB would need time to see the full impact of bumper funding operations it has used to help banks.

Several policymakers, led by the German Bundesbank chief Jens Weidmann, had said in recent weeks the ECB needs to prepare an exit strategy after the massive cash injection - comments that led to a steepening of the money market curve as markets priced in higher rates in 2013 and 2014.

But Alessandro Giansanti, senior rate strategist at ING, said markets had scaled back chances of higher rates in 2014 after the meeting, with 3-month Euribor rates coming further under pressure to hit their lowest since June 2010.

The bank-to-bank rate, traditionally the main gauge of unsecured interbank euro lending and a mix of interest rate expectations and banks' appetite for lending, fell to 0.766 percent from 0.768 percent in the previous session.

Giansanti said the ECB would have to see the inter-bank market functioning again to unwind the measures it took to shore up the banking system.

"The peripheral banks are still not able to get money in the interbank market so they are relying too much on the ECB," he said.

But with domestic banks in struggling peripheral countries increasingly leveraged with their own risky debt, such normalization may still be a way off.

"I think the pressure is going to continue on Spain and there's going to be more pressure for the ECB to provide further liquidity," Nolan added. "I don't think we are at the stage of an exit strategy yet."

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