September 18, 2012 / 5:08 AM / 5 years ago

Hesitant Spain puts euro, share rally into reverse

5 Min Read

Traders are pictured at their desks in front of the DAX board at the Frankfurt stock exchange September 14, 2012.Remote/Amanda Andersen

LONDON (Reuters) - European shares and the euro slipped on Tuesday, leading a broader drop in risk assets as investors turned their attention from central bank stimulus to slowing global growth and doubts about Spain's desire for an international aid package.

Taking their lead from weaker Asian markets, European equities continued to fall away from 14-month highs hit last week after the Federal Reserve promised to keep pumping money into the U.S. economy and the euro zone's bailout fund got crucial backing from a German court.

London's FTSE 100 .FTSE, Paris's CAC-40 .FCHI and Frankfurt's DAX .GDAXI were down between 0.5 and 0.7 percent by 8:50 a.m. EDT (1250 GMT), pushing European .FTEU3 and global indexes .MIWD00000PUS into negative territory.

In the United States, where housing market and current account data will be in focus alongside problems at chip maker AMD, Wall Street is expected to open lower for the second day running.

Investors are becoming worried that Spain may try to avoid accepting what would be a politically unpopular EU/IMF bailout. Taking aid is a condition for the European Central Bank to start buying bonds of any troubled euro zone government under its plan to lower debt yields which has helped to achieve the recent lull in the euro zone crisis.

"We take the view that delaying tactics by the Spanish government to request aid could backfire and lead to renewed upward pressure on yields because markets are effectively assuming that an aid request is more or less a done deal," said Rabobank economist Elwin de Groot.

Uncertainty was evident in bond markets. German Bund prices rose 32 ticks as the reversal of the recent falls continued although borrowing costs for Italy and Spain eased.

Ten-year Spanish bond yields dipped back below the 6 percent barrier which was breached on Monday, to stand 5 basis points lower on the day at 5.97 percent.

The euro dropped 0.5 percent, putting it back below $1.306. The yen was also feeling the pressure, with speculation that the Bank of Japan might loosen policy on Wednesday following last week's move by the U.S. central bank.

Sterling plus the Australian and New Zealand dollars also softened against the U.S. currency after all three had made recent sharp gains. The Aussie slipped after the Australian central bank left the door open for a rate cut.

"Unless we get this (Spanish) uncertainty out of the way, we expect the euro to face some resistance around its highs," said Adam Myers, senior currency strategist at Credit Agricole.

Comments by Belgian ECB policymaker Luc Coene also put downward on the euro. He said on Monday that an interest rate cut, charging banks to deposit cash and a new offer of ultra-cheap long-term funding were all potential options for the ECB.

Growth Focus

Coene also warned that Spain's borrowing costs would jump again unless it accepts an aid program.

But Madrid, which is trying to cash in on the current benign conditions with two bond auctions this week, saw its borrowing costs fall slightly at a 4.5 billion euro sale of short-term debt. [ID:nEAP50WI00]. Greece also sold three-month T-bills.

A more serious test will be on Thursday when Spain attempts to sell the same amount of 3- and 10-year debt. It hasn't tried to auction as much in one sale since early March, when an ECB decision to flood the banking system with cheap three-year loans had also temporarily calmed the markets.

Economic worries were also back in focus. The Swiss government cut its growth forecast for this year and next, saying signs of a worldwide economic slowdown had intensified. These comments came after fears about China's wobbling economy had hit shares in commodity-rich Australia.

Oil prices, which are up almost 10 percent since early August, were holding near $114 a barrel by mid-morning following a drop in the previous session, while gold edged lower.

"Investors are really in defensive mode today, and probably will stay that way until Thursday, when we get the fresh read on manufacturing out from China," said Juliana Roadley, a market analyst at Commonwealth Securities. A flash reading of China's purchasing managers' index for September is due on September 20.

Brighter news came from Germany, where the ZEW index of morale among analysts and investors rose more than expected in August following the ECB's promise to preserve the euro.

"The rise clearly reflects the positive reaction to the ECB's announcement of the new bond-buying program, which has boosted financial market sentiment and significantly reduced the big systemic risks to the euro," said Aline Schuiling, Senior Economist, at ABN Amro.

Additional reporting by Anirban Nag; editing by Anna Willard/David Stamp

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