Investor sentiment improved briefly in the morning as electoral results in Greece suggested the country would not drop out of the euro currency union, a scenario that would have put severe stress on Spain's markets.
But that market relief quickly faded in Madrid as it became clear that Spain's fundamental economic and fiscal problems remain huge.
The interest rate on Spain's 10-year bonds — an indicator of market confidence in how well a country can pay down its debt —hit a fresh eurozone era high of 7.18 per cent before easing in late afternoon trading to 7.10 per cent. Stocks fell 2.7 per cent in Madrid.
The bond yield's alarming 0.23 percentage-point rise put it firmly in the 7 per cent range that prompted the other three eurozone countries to ask for a bailout.
The yield indicates at what rate a government can raise money from financial markets when it holds bond auctions. While Spain would be able to afford the current high rates for a few weeks at least, it would find them too expensive in the longer term. If the bond rates do not fall back down, Spain may have to ask for foreign aid to finance itself.
Andrew Wilkinson, chief economic strategist at trading firm Miller Tabak & Co., said it's impossible to know how long Spain — which will next tap bond markets on Thursday — can survive paying the current rates before needing a rescue.
"It could go through a few (bond auctions) before you'd argue that this is unsustainable," he said. "It's like applying a vise to a prisoner and making him squeal. How much can he take?"
Spain has already requested a bailout for its banking sector, which is saddled with billions of euros in soured investments after the implosion of a real estate bubble. The country is expected to announce by Wednesday how much it will tap from a €100 billion ($126 billion) eurozone fund after two independent auditors complete evaluations of the banks' needs.
But because the government is ultimately responsible for repaying the banks' bailout money, the deal has increased fears about the size of public debt. If the government cannot get the bailout money back from the banks, it will be saddled with the losses.
Those losses could prove too much to handle for the government, which is already struggling with a second recession in three years and the highest unemployment rate among the 17 nations that use the euro.
Financing the Spanish government, however, would likely be too expensive for the eurozone bailout funds to handle. Spain's €1.1 trillion ($1.39 trillion) economy is bigger than those of Greece, Ireland and Portugal combined.
"Lending money is all about confidence, and that is shot to bits right now," said Gary Jenkins, managing director of the Swordfish Research Ltd.
Some analysts said the pressure on Spanish bonds may have been exaggerated, but reflected growing concerns that the eurozone still seems unable to contain the financial crisis that has roiled it for years.
"It is simply the result of the market reflecting once again the notion that a comprehensive solution regarding containing the financial crisis in Europe hasn't come forward yet and that still much work has to be done in order for investors' confidence to return," said Ishaq Siddiqi, market strategist with ETX Capital.
Spain has said repeatedly it cannot sustain such high interest levels for its bonds much longer. Finance Minister Cristobal Montoro issued an urgent plea Monday for the European Central Bank to buy its bonds and force the rate down. The ECB did that last year but then stopped, as it is against its rules to directly help governments. Its primary function is to control eurozone interest rates.
It is impossible to predict whether investors will continue to demand such high rates to lend to Spain and push the country to take a bailout, said Hans Martens, chief executive of the Brussels-based European Policy Center.
"I think if it happened, it would be completely illogical because I think there's a lot more growth potential in Spain. The economy is bigger, they are more competitive, so I hope they will be given the time to grow out of it," he said.
Meanwhile, Spain's central bank announced Monday that bad debts held by the country's banks rose to a new 18-year high in April, indicating more companies and individuals are failing to make payments on time. The amount stood at €152.7 billion, or 8.72 per cent of the loans held by Spanish banks. The rate was 8.37 per cent in March.
Sarah DiLorenzo in Brussels contributed to this report.
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