By Paul Day
MADRID (Reuters) - Spain's borrowing costs hit a new euro era high at a debt auction on Thursday, a few hours before it is expected to shed light on the dire state of its weaker banks and possibly make a formal request for European Union funds to rescue them.
The auction proved the Spanish Treasury can still borrow on international markets, albeit at a high cost, and it made the best of solid demand by selling 2.2 billion euros ($2.8 billion) in bonds, above the targeted amount.
"We want to emphasize the strong demand despite the current situation on the markets," an Economy Ministry source told Reuters.
However, the rocketing yields contrasted with France's sale on Thursday of bonds maturing in 2014 for just 0.54 percent, as concerns that Spain might have to take a full sovereign bailout meant that international investors are opting for less risky debt. Madrid had to pay 4.706 percent for the same maturity.
While the government does not give immediate breakdown of buyers in primary auctions, data shows international investors are steering clear of Spain and have left the often troubled domestic banks to buy up the government's bonds.
"They got it away, it's about the most positive thing you can say about it. Also it's above the modest target they have set for themselves, but the yields are not anything to be too pleased about it. These are high levels," said Elisabeth Afseth, fixed income analyst at Investec.
Spain, which is in its second recession since 2009 and has the highest unemployment rate in the European Union, is the latest euro zone country in the firing line after Greece, Ireland and Portugal, which have already taken bailouts.
Madrid may make a formal request for up to 100 billion euros in aid for its banks at a Luxembourg meeting of euro zone finance ministers, who already approved the plan informally earlier this month.
The demand would follow the release of the results of an independent audit of the Spanish banks, which have been hammered by the effects of a property crash and the recession.
Banking sources believe this will say the lenders need to raise a further 60-70 billion euros to improve their capital position.
A lack of information on the bank rescue has helped to drive yields on Spanish government debt in recent weeks to levels deemed unsustainable in the medium term.
However, Spanish government bond yields fell further after the auction. The 10-year yields were last 15 ticks lower on the day at 6.61 percent, with shorter-dated yields falling even more.
The Treasury sold the bond due in July 2015 at a yield of 5.457 percent compared with 4.876 percent in May, while the longer dated July 2017 bond sold for 6.072 percent, up from 4.960 percent last month.
This was the highest auction yield for a five-year bond since 1997, two years before Spain adopted the euro.
Spain has sold about 61 percent of its planned issuance in medium and long-term debt following Thursday's auction, as it got ahead of schedule at the start of the year when banks used cheap cash from the European Central Bank to buy bonds.
The effect of the massive ECB loans of three-year cash is fading fast, and yields have leapt sharply since the last liquidity offer in February.
(Additional reporting by London debt desk and Julien Toyer; Editing by Julien Toyer and David Stamp)