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Debt Crisis: Spain borrowing costs fall but relief may be short-lived

SPAIN’S 10-year borrowing costs fell to their lowest level since January in an auction today although the relief from market pressure may be short lived as Prime Minister Mariano Rajoy hesitates over seeking an international bailout.

The yield on the benchmark 2022 bond fell to 5.666pc with almost three times more offered than the amount sold.

Demand was also strong for a three-year bond.

The Treasury sold a total of €4.8bn in the bonds, above its target.

Investors have been encouraged by the European Central Bank's decision to buy the debt of troubled governments such as Spain's, provided they first request help from the euro zone's rescue funds.

Such a bailout may bring demands for more unpopular austerity, and Rajoy has repeatedly said he is studying an aid request but does not want Europe to dictate conditions.

Markets expect that he will be pushed into a request sooner rather than later, as borrowing costs may start rising again if the ECB purchases failed to materialise.

"The relaxation of the markets is temporary, and if investors start thinking Spain is moving away from a rescue, that would be negative," said Soledad Pellon of IG Markets in Madrid.

Spain is at the heart of the euro zone debt crisis, now in its third year, with investors worried it will not be able to bring down its public deficit and control its debt due to a recession.

Market reaction was muted after Thursday's auction. The spread between yields on Spanish and Germany benchmark bonds, which is a measure of the perceived risk of investing in Spain, widened slightly from Wednesday's close to 419 basis points.

This was still way off a July peak of well over 600 basis points.

With many of Spain's 17 regions unable to meet debt payments this year, the central government is stepping in and bailing them out to the tune of 18 billion euros, putting further tension on finances.

Frustration over taxes and separatist sentiment are growing in cash-strapped Catalonia, a powerful northeastern region that generates a fifth of Spain's economic output, has its own language and is largely self-governing.

Rajoy is scheduled to meet today with Catalan President Artur Mas, who will press him to give the region more tax freedom, even though it is depending on the central government for a €5bn bailout.

As well as reassuring investors Spain could meet its debt repayments, a bailout would mean more rigorous control of its budget after consistently missing deficit targets in recent years, analysts say.

Spain's credit is rated one notch above junk grade by the Moody's agency, which is due to complete a review of Spain by the end of the month.