MADRID (Reuters) - Doubts over the details of an agreement by European leaders to free emergency funds to buy sovereign debt and allow direct bank recapitalization will hang over European auctions next week, with supply from Spain a key test of market faith in the accord.
Spain will auction around 2.5 billion euros ($3.1 billion) of three bonds on Thursday, maturing in 2015, 2016 and 2022. The exact target sale amounts will be announced on Monday at around 8.40 a.m. EDT.
Spooked by politicians’ slow progress in dealing with the debt crisis, investors have demanded euro-era-high premiums to buy debt issued by Italy and Spain. Spanish leaders have warned they cannot continue to borrow at current levels for long.
The agreement by EU leaders early on Friday to help the Spanish and Italian governments lower borrowing costs without enforcing greater austerity measures surprised markets, which had expected little new from the Brussels summit.
“There is political momentum, which is a positive for the auction, but I think today’s reaction is a bit overdone because there will be a lot of follow through as the market tries to assess the details,” BNP Paribas rate strategist Ioannis Sokos said.
The deal was seen as a political victory for Italian Prime Minister Mario Monti and his Spanish counterpart, Mariano Rajoy, over German Chancellor Angela Merkel, who had said there was no need for emergency measures earlier this week.
Leaders under pressure to prevent a breakup of the single currency also pledged to create a single euro zone banking supervisor, a landmark step towards a European banking union.
Spanish and Italian debt rose sharply in value on the secondary markets on Friday, trimming yields on both countries’ benchmark 10-year bonds by around 40 basis points on the day.
“It really depends on what comes out in the next few days. Right now there is intense uncertainty,” a Madrid-based fixed income trader said. “The fall ... in the (Spanish) 10-year benchmark yield is normal after yesterday’s announcement, but the question is whether it’s sustainable.”
While the accord says new austerity measures will not be forced on nations using the new mechanism, Merkel said conditionality would still apply, the trader noted - a lack of clarity that could temper market enthusiasm for the deal.
Spain’s Treasury, which has already raised more than 61 percent of its 2012 gross issuance goal, will hold 12 more bond auctions this year from which it must raise 33.3 billion euros, or an average of just under 2.8 billion euros an auction.
The government made the most of a flood of cheap loans from the European Central Bank at the beginning of the year, front-loading its issuance plans to coincide with the ECB’s trillion euro two-stage Long-Term Refinancing Operation (LTRO).
Since March, Madrid has raised an average of just 2.4 billion euros at each bond auction as the positive effect of the ECB’s December and February liquidity injections has faded.
Markets have been less demanding of Italy, which does not plan to sell bonds next week, but pressure on technocrat premier Monti has ramped up in the last week, with Rome’s benchmark borrowing costs hitting six-month highs on Thursday.
Markets want Monti to follow through on reforms to spur economic growth that will help Italy tackle the world’s fourth-largest debt pile.
“The measures announced (by EU leaders) are short on detail, full of loose ends and of limited benefit to Spanish and Italian sovereign debt,” said Nicholas Spiro of Spiro Sovereign Strategy in London. “The rescue funds’ capacity to purchase government debt is very limited and, even with leverage, not credible enough to turn around sentiment.”
While market attention in the wake of the European accord will be focused on periphery countries’ debt, one of the euro zone’s triple-A-rated core economies the Netherlands will also offer a minimum 4 billion euros of new five-year bonds.
The bloc’s economic powerhouse and paymaster Germany, whose perceived status as a safe haven has seen investors accept negative real interest rates to hold some of its debt, will meanwhile auction four billion euros of five-year bonds.
The sale should be helped by around 40 billion euros of German coupon and redemption payments.
Bunds slipped on Friday as Spanish bonds rallied, with 10-year German yields 10 bps higher at 1.61 percent, having briefly risen above those of their U.S. counterparts for the first time since early February.
The euro’s second-biggest economy France will auction between 7 billion and 8 billion euros of OAT treasury notes the same day as Madrid taps the market.
“The appetite for core bond markets will be pretty significant (to see) after the positive surprise from the EU summit,” rate strategist at RBS Harvinder Sian said.
“I think they’ll clear okay, but the most focus will be on the Spanish auction and how well the market sees appetite for Spanish bonds post-EU summit.”
($1 = 0.8047 euros)
Editing by Catherine Evans