The eurozone debt crisis has flared dangerously again as investors ran for cover amid fears Spain will need a full-blown government bailout.
The FTSE 100 Index was more than two per cent or 131 points lower at 5520 amid speculation a raft of Spanish regions were poised to ask for government bailout funds, increasing the likelihood the country itself will turn to the EU for help. The yield on 10-year Spanish bonds rose to a euro-era high of 7.5 per cent in a sign investor confidence in the country’s ability to control its finances is increasingly waning.
The pound continued to soar against the battered euro, hitting 1.28, as the eurozone debt problems drove investors to the relative safe haven of the UK currency.
Vincent Forest, economist at the Economist Intelligence Unit, said: “It is now clear that Spain has entered a self-defeating cycle of austerity and economic contraction.”
Borrowing costs also rose in Italy, which has been caught up in fears it may soon be pushed into asking for assistance as well.
Greece also returned to focus as officials from the EU, European Central Bank and International Monetary Fund prepared to meet with the country’s government to discuss progress with its budget pledges.
If Greece is unable to deliver the spending cuts and tax reforms necessary then the so-called troika are unlikely to be forthcoming with further aid and a Greek exit from the single currency bloc will be back on the cards.
David Jones, chief market strategist at IG Index, said: “Those of a superstitious nature may be drawing parallels with this time last year, when heightened concerns about Greece saw the FTSE lose 1000 points in the first two weeks of August.”
Spain has already been granted a 100 billion euro (£80bn) bailout for its banks, but has so far avoided following in the footsteps of Greece, Ireland and Portugal and taking EU assistance for the country.
But on Friday the Valencia region said it would be the first to seek financial help from an 18 billion euro (£14bn) fund set up to help the country’s regions.
And on Sunday Murcia’s government said it was “studying whether to apply” for assistance.
To heap more pressure on the country, the Bank of Spain said the economy contracted by 0.4 per cent in the three months to the end of June, having shrunk by 0.3 per cent in the previous quarter.
The markets fear the prospect of double-disaster: Spain needing a bailout that would strain the eurozone’s bailout funds, and a possible Greek abandonment of the euro.
Market report: Business Tuesday, Page 2.