Article Highlights

  • Spain's PM faces no confidence vote
  • Investors fret about planned coalition in Italy
  • Italy 2-year bond yield up over 30 bps
  • German Bund yield set for biggest weekly fall since 2012
  • Spanish, Italian stocks tumble, euro falls
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Borrowing costs in southern Europe shot up on Friday and stock markets in Milan and Madrid tumbled as a no-confidence motion mooted against Spain’s prime minister exacerbated a selloff sparked by growing political risk in Italy.

Spain’s socialist leader Pedro Sanchez on Friday said his party would call a snap election if it won the motion it put forward against Prime Minister Mariano Rajoy over a graft case involving members of his People’s Party .

The news sparked a sharp selloff in Spanish bonds and stocks, some of the biggest weekly bond market moves since the euro debt crisis in 2012, while the euro extended its falls.

It also gave investors a fresh incentive to get out of Italian assets, which have been rattled by the prospect of a spendthrift coalition government comprising the anti-establishment 5-Star Movement and far-right League.

Italy’s 2-year bond yield climbed more than 30 basis points to its highest in over four years at 0.67 percent <IT2YT-RR>. It was set for its biggest daily jump in 5 years and its biggest weekly rise since the euro debt crisis in 2012.

A little over a week ago it was trading below zero percent.

Ten-year bond yields in Spain, Italy and Portugal were up 9 to 11 bps each. Spain’s benchmark stock index tumbled 2.4 percent.

“It’s the same theme in Spain and Italy but different stories,” said Investec chief economist Philip Shaw.

“But while in Italy you have the prospects of a highly confrontational government, in Spain even if we get fresh elections the mix of parties likely to make up a new government would likely be the same as the present one.”

The closely watched Italy-Germany 10-year spread, seen by many investors as a proxy for sentiment towards the euro zone, was at its widest in four years at 215 bps.

German bonds, viewed as one of the safest assets in the world, benefited from the turmoil, with 10-year Bund yields set for their biggest weekly fall since the euro zone debt crisis in 2012, down 18 bps.

Britain’s 10-year gilt yield was on track for its biggest weekly fall since just after the 2016 Brexit vote .

Demand for U.S. Treasuries was also lifted by the sell-off in southern European markets.

The euro extended losses and fell by over half a percent to a 6 1/2-month low at $1.16465.

A sell-off in Italian and Spanish stocks deepened, with Italy’s FTSE MIB benchmark down 2.2 percent. Spain’s IBEX was on course for its worst day since global market turmoil in early February.

Bank stocks were the worst-hit with the euro zone banks index down 2.7 percent and also set for its biggest fall since early February. Nearly twice the average daily volume was traded in Spain’s Caixabank and Santander as well as in Italy’s Banco BPM and Intesa Sanpaolo .

“The underlying basics (for Spain’s economy) long-term are strong,” said a Madrid-based executive at an investment advisory firm who asked not be named.

“The country is growing but uncertainty is never good for any type of outlook and that’s going to impact the stock market.”

SPAIN RATTLED

Spanish 10-year government bond yields rose 9 basis points to 1.52 percent, pushing the gap over German Bund yields to 112 bps — its widest since early January. It has blown out 16 bps this week, the biggest spread widening in almost two years.

“Up until now, if you put Catalonia to one side, it was a relatively benign environment,” said Pierre Bose, head of European strategy at Credit Suisse, adding that he remained positive on Spanish equities.

“This increases the level of noise, but does it change the earnings pattern at this point? Not really.”

The cost of insuring exposure to Spanish debt in the five-year credit default swaps market rose to its highest since the end of October at 65 bps, according to IHS Markit. But Italian CDS traded at 166 basis points, the highest in nearly a year.