A flood of easy money courtesy of the European Central Bank made for a calm start to 2012 but a poor Spanish bond sale last week signals it may only have been a lull before the debt storm breaks, analysts warn.
The ECB injected roughly one trillion euros ($1.3 trillion) into eurozone banks at auctions in December and February, helping to ease concerns banks would face a funding crunch.
Some of this cash ended up in the sovereign bond markets, helping reduce the rates countries need to pay to raise funds after a year of high tension over whether Italy and Spain -- the eurozone's third- and fourth-largest economies -- might also need to be bailed out after Greece, Ireland and Portugal.
"The first quarter was exceptional for eurozone state borrowing," said Jean-Francois Robin at France's Natixis bank.
The first three months of the year are important as countries often try to meet a huge chunk of their annual borrowing needs at the outset and they made the most of the early calm.
"Paris and Berlin borrowed at historically very favourable rates and Madrid got a long way towards covering its financing needs this year," noted Robin.
Spain covered 43 percent of its annual medium- and long-term financing needs in the first quarter, taking advantage of rates of around 4.0 percent compared to near 7.0 percent at the height of the crisis late last year.
But in the first week of April the calm on European debt markets abruptly ended.
Spain barely raised the amount it sought in a bond auction on Wednesday and had to pay investors sharply higher rates just after announcing a tough 2012 budget that aims to make a whopping 27 billion euros in savings.
Madrid's warning that its public debt will jump by 10 percentage points this year to nearly 80 percent of gross domestic product (GDP) clearly rattled investors who also faced the prospect of an economy slipping deeper into recession.
While ECB liquidity measures helped shield Madrid from immediate danger, economist Raj Badiani at IHS Global Insight warned the risks are expected to intensify next year as Spain is battered by recession and high unemployment and bad real estate assets drag down banks.
This would make it difficult for Spain to achieve its target of reducing its public deficit to the EU ceiling of 3.0 percent of GDP by austerity measures alone, he said, and raised the possibility it would need some sort of help from its European partners.
"This could entail the ECB providing more protection than its current policy of making limited Spanish bond purchases in the secondary market," he said.
However, ECB chief Mario Draghi made it clear on Wednesday that such a move was not on the cards, although the central banker would not rule out further action to support the region's banks.
"Widespread hopes ... that the ECB would use the might of its theoretically unlimited balance sheet to fire a so-called 'silver bullet' into the heart of the broader eurozone crisis by buying up or somehow guaranteeing large portions of the Italian and Spanish (debt) have all but evaporated," said Jonathan Loynes at Capital Economics.
Bond yields of weaker eurozone states are moving higher as did the gap with those of German government bonds, the benchmark measure.
The yield on Spanish 10-year bonds jumped to 5.735 percent from 5.332 percent at the end of March, with the spread with German bonds widening to over 4.0 from 3.54 percentage points.
The spread between German and Italian bonds widened to 3.67 from 3.31 percentage points.
France, which lost its coveted top triple-A rating from Standard & Poor's rating agency earlier this year and faces concerns about the competitiveness of its economy, saw the spread on its bonds rise to 1.25 from 1.09 percentage points.
"The spreads, which reflect the degree of investor confidence (in a country) are clearly widening again and the short-term outlook is not particularly positive," BNP Paribas analysts said in a client note.
Elections in France and Germany may also raise concerns about changes to eurozone policy and the threat of recession still hangs over the bloc.
The latest economic data present a grim picture, with German industrial output declining by 1.3 percent in February and a survey of purchasing managers suggesting a manufacturing slowdown and that the eurozone has gone into recession.
"Not only does that undermine the chances of Germany spending more on other countries' exports but, if the hyper-efficient and competitive German industrial sector cannot stay out of recession, what hope is there that the peripheral economies will achieve the growth they need to get out of their fiscal mess?" asked Capital Economics' Loynes.