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Spanish, Italian government borrowing costs jump as Grexit fears spread

LONDON (Reuters) – Government borrowing costs in Europe’s indebted southern countries shot up on Monday as investors began to worry that a vote in Greece could see it become the first country to leave the euro currency bloc.

In glimpses of the contagion that roiled markets during Europe’s 2011-2012 debt crisis, Italy, Spain and Portugal saw their 10-year bond yields rise sharply, while German equivalents — seen as a safe haven in times of stress — fell.

If Greece were to exit the euro zone it could raise the risk for investors that other heavily-indebted member states might follow suit.

As talks with international creditors over a reform-for-cash deal broke off at the weekend, Athens closed its banks and introduced capital controls, pledging to hold a vote to see if Greek people will agree to its lenders demands on Sunday.

A sharp early move on Monday saw the difference between Spanish and benchmark German borrowing costs balloon to the widest level seen in a year, before tightening slightly as investors started to weigh up the prospect of the referendum seen as a de facto vote on continued membership of the euro.

Polls have shown the majority of Greek people want to stay in the euro, but with the leftist Syriza-led government urging its people to reject creditors’ terms for further bailout money, many remain cautious.

“It’s tossing a coin … but if I had to position myself I would do it on the side of a Grexit,” said Marius Daheim, senior fixed income strategist at SEB.

“This government was elected by a majority of the Greek population on an anti-austerity bill so for that reason I would assume that a lot of the same people who voted for Syriza earlier this year would also be voting against this reform proposal.”

Making matters worse, Greece is set to miss a 1.6 billion euro ($1.76 billion) loan repayment to the International Monetary Fund that falls due on Tuesday.

A default may prompt the European Central Bank to increase the haircuts on the collateral it accepts to fund Greek banks, or pull the funding, a move which could put savings in jeopardy and stoke public anger in Greece against the euro system.

KEEPING FAITH

Portuguese <PT10YT=TWEB>, Italian <IT10YT=TWEB> and Spanish 10-year yields <ES10YT=TWEB> were all up around 20-25 basis points on the day at 3.02 percent, 2.35 percent and 2.31 percent, respectively.

German equivalents, the bloc’s benchmark, were down around 14 bps at 0.78 percent, having touched a one-month low of 0.71 percent <DE10YT=TWEB> in early trade.

Greek bond yields also rose around 10 percentage points, according to financial platform Tradeweb, although strategists cautioned that capital controls would likely restrict trading from domestic banks which hold most of the country’s debt.

Athens’ main stock market was closed on Monday and is due to stay shut all week. <0#GRTSY=TWEB>

Despite the outsized moves, bankers said trading was light in a market where it is increasingly difficult to buy and sell bonds and the ECB is hoovering up large amounts of debt with its trillion-euro stimulus program.

But amid the furor, some investors kept faith in the resolve of European policymakers to keep Greece in the euro and firewalls put in place since the financial crisis to stem market contagion.

Goldman Sachs speculated last week that the European Central Bank may step up its bond-buying programs in the wake of a Greece default to soothe investor nerves.

“The threat to the euro zone is perceived as being much less than in 2011 when the region was much more fragile following the global financial crisis,” said Lorne Baring, managing director, B Capital Wealth Management.

“We expect downward pressure to resume with this new twist in the Greek saga but it may be short-lived as the political pressure to resolve the situation mounts.”

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