Irish and Spanish debt auctions attracted strong demand on Tuesday and allayed concerns about the pressure on costs of funding for eurozone countries saddled with high debt and poor growth. Irish debt spreads fell from three-month highs and the cost of protecting against a sovereign default fell from 17-month peaks after Dublin hit the top of its 1.5 billion euros target range in spite of jitters over the escalating cost of cleaning up its banking sector.
Yields that Ireland's central bank governor has called "ridiculous" fell compared to a month ago, as did Spain's, helping the euro extend gains against the dollar and come off 7-week lows against the yen. The average return investors demanded on Ireland's 10-year bond fell to 5.386 percent compared to 5.537 percent at a sale in July. Spain sold 5.51 billion euros of 12- and 18-month treasury bills at yields of 1.84 and 2.08 percent respectively, down 38 and 24 basis points on July.
Central bank governor Patrick Honohan warned that governments needed to convince investors that they were committed to cutting their budget deficits, even as he hinted the cost of the bank bailout may rise further. Ireland's budget deficit ballooned to 14 percent of gross domestic product, the highest in Europe, last year due to the cost of propping up nationalised lender Anglo Irish and it could explode to around 20 percent this year if Dublin injects an additional 10.05 billion euros into the bank.
The Anglo injection is meant to be a one-off and Honohan reiterated on Tuesday that Ireland was committed to reducing its deficit to an EU target of 3 percent of GDP by 2014. Fitch ratings agency told Reuters that Dublin may have to slash more than the 3 billion euros in savings earmarked for the 2011 budget to fully restore investor faith in Irish finances.
Dublin attracted total bids of 5.1 billion euros in Tuesday's sale, the strongest demand in an auction so far this year and in stark contrast to the ice-cool reception for Irish paper in the secondary market in recent weeks. Spain, which has hinted it could backtrack on some of its planned cuts in infrastructure spending, sold 5.51 billion euros of debt, at the top end of its target of 4.5-5.5 billion euros. The spread on Spanish 10-year paper over German government debt contracted by around 9 basis points to 168 basis points on Tuesday.