Spain plans to auction up to 3.5 billion euros ($5 billion) of bonds on Thursday as the European Central Bank meets on policy, with investors hoping the ECB will signal a more aggressive approach to fighting the euro zone's debt crisis.
Spanish Economy Minister Elena Salgado, speaking on Wednesday night after a crisis meeting on the economy with Prime Minister Jose Luis Rodriguez Zapatero, said the bond sale would take place as scheduled despite a surge in Spanish and Italian bond yields to 14-year highs in the past several days.
We think the tensions will last a few more days, but the bond auction will go ahead on Thursday, Salgado said.
The yield on Spain's 10-year bonds climbed as high as 6.50 percent on Wednesday because of investor doubts about Madrid's ability to continue financing its debt over the long term, before drifting back to close at 6.27 percent.
Analysts say that if yields go much higher and stay there for months, markets could force Spain, the euro zone's fourth biggest economy, to follow Greece, Ireland and Portugal in seeking an international bailout.
Hearing Zapatero had canceled his holidays showed the situation was desperate. The 7 percent (yield) mark is a psychological barrier and is just not sustainable because it's far too costly to finance at these levels, said Jo Tomkins, analyst at consultancy 4Cast.
The ECB holds its monthly policy meeting in Frankfurt on Thursday and investors are hoping it will offer some form of reassurance to financial markets.
Euro zone leaders agreed at a summit last month to give the bloc's bailout fund sweeping new powers to help indebted states and intervene in the bond market, but the changes are unlikely to be passed by national parliaments until late September at the earliest. So for now, the ECB may be the only institution able to act quickly and powerfully to defend the euro zone.
Fund managers think the ECB may decide on Thursday to reactivate its emergency programme to buy bonds of weak states from the secondary market. The plan, deeply disliked by some ECB policymakers for compromising the central bank's core mission of controlling inflation, has been suspended for over four months.
If the ECB does not revive the programme, central bank president Jean-Claude Trichet may at least indicate willingness to use it if the crisis worsens, some analysts believe.
The ECB, which has raised official interest rates twice this year, may also signal it will put any further tightening on hold because of slowing economic growth in the euro zone and globally, even though inflation is well above target.
In Italy, the euro zone's third biggest economy, Prime Minister Silvio Berlusconi promised on Wednesday to step up economic reforms and called for a broad-based effort in the country to fight the market turmoil.
The government and parliament will act, I hope, with a large political and social consensus to fight every threat to our financial stability. Today more than ever, we need to act all together, said Berlusconi, in a speech which did not give substantial new details on policy.
Berlusconi is due to meet employers' groups and unions on Thursday to try to thrash out a plan to stimulate the economy. But the head of the largest union, the left-wing CGIL, responded coolly to his speech.
Susanna Camusso said it was disappointing and lacked concrete proposals, and that negotiations were already getting off on the wrong foot. The leader of the opposition Democratic party, Pierluigi Bersani, said Berlusconi should resign.
Chiara Corsa, analyst at Italian bank Unicredit, said of the speech: I didn't have very high expectations but even so the content was quite disappointing. He showed no willingness to bring forward any of the austerity measures to next year, which we had hoped for and markets would have appreciated.
Italian Economy Minister Giulio Tremonti held two hours of emergency talks with the chairman of euro zone finance ministers, Jean-Claude Juncker, in Luxembourg on Wednesday but neither disclosed anything of substance after the meeting. Tremonti also talked with European Monetary Affairs Commissioner Olli Rehn.
In addition to Italy and Spain, some investors are becoming jittery about the finances of France, the euro zone's second biggest economy. The spread of 10-year French government bonds above German Bunds hit a euro lifetime high of 0.81 percentage point on Wednesday.
This is problematic partly because any lasting solution to the euro zone's crisis may have to involve a drastic expansion of its 440 billion euro bailout fund. That would put a greater financial burden on France, a big contributor to the fund, and could push up its yields further.
With euro zone governments struggling to contain the crisis, some analysts believe other major governments around the world, in the Group of Seven or Group of 20 nations, may eventually intervene to try to calm the markets.
Official sources in several G7 countries say they are not aware of any move so far to involve the G7 or G20, but that France, which holds the chair of both groups this year, might consult those forums if the turmoil persists.
Canadian Finance Minister Jim Flaherty said on Wednesday he had been holding discussions with his G20 colleagues about the global economic situation.
I've had discussions of course with what's been going on of late. We continue to monitor the situation and I'll leave it at that, he told Reuters in Toronto.
(Additional reporting by Paul Taylor; Writing by Andrew Torchia, editing by Tim Pearce)