Spanish bond yields surged 17 basis points Friday morning, causing them to hit 6.2 percent and remain above the 6 percent danger level. The jump caused 10-year-yields to drop by the most in more than two weeks and came after ratings agency Fitch downgraded the nation by three notches late last night.

The nation is now rated BBB by Fitch, with the agency arguing that the huge cost of recapitalising the country’s banks poses a sizeable threat to its credit status. The downgrade now places Spain in the same league as Bahrain and Kazakhstan and has been put on negative watch.

Douglas Renwick, Senior Director of Fitch told CNBC this morning: “As long as Spain is able to find its day-to-day budget there’s not a problem but as soon as they start asking for E60bn – or may even E100bn…we have a problem. The idea behind supporting the system up front is to restore confidence in the banks.”

Renwick added that, in order to make their downgrade decision, the agency took into consideration the debt dynamic and the fact that the recession is Spain is going to drag out a lot longer than previously expected. “They will miss their deficit targets”, he said. Turning to the rest of Europe, he spoke of the possibility for other nations involved in the restoration process to become subject to ratings changes. Speaking of Germany in particular – which currently stands at AA stable – he said: “The more you share the burden across the euro zone, the more you are going to impact the stronger ratings. That is not to say that all these ratings are going to begin dropping.”

Resolution in the air?

Yesterday’s solid auction action saw Spain sell off 2.07 billion euros of securities surpassing the maximum target of 2 billion. Investors and forex brokers, who appear to be smelling a resolution for Spain’s on-going economic crisis in the air, bought up 611 million euros of benchmark 10-year bonds at an average yield of 6.044 per cent, up from 5.743 per cent at the previous auction on April 19. While 30-year bond yields declined 16 basis points to 6.27 per cent, falling for the sixth consecutive day. “There was a big move downward in Spanish yields going into the auction, which seemed to have been driven by the hope that there is shortly to be joint action by several of the major central banks,” said Lyn Graham-Taylor, a fixed-income strategist at Rabobank International in London. “Spain can clearly still borrow in the markets but it must pay high yields for the privilege.”

A report leak Thursday from the International Monetary Fund (IMF) – due for official release Monday – also seemed to shore up investor sentiment over the likelihood of an impending bailout. The organisation reportedly predicted that Spanish banks will need a cash injection of at least 40 billion euros (32 billion pounds) in order to stabilise its banks. With Angela Merkel’s comments adding fuel to an already smouldering speculatory fire when she expressed further willingness to hold the euro zone together.

Standard and Poor’s also released their own statement on the Spanish scenario, admitting that struggling banks will need government or EU aid if they have to book loan losses of 80 to 112 billion euros ($100-140 billion) this year, they predicted. “Pressure is building for Spanish banks to recognize provisions against the likely losses in both 2012 and 2013 already this year”, a statement from the ratings agency said.

Sarah Cox, Staff Writer