By Paul Day
MADRID (Reuters) - Spain's short-term borrowing costs rose to their highest level since 1997 in a debt sale on Tuesday as investors worried the country will soon be forced to ask for international aid.
The euro zone's fourth-largest economy has become the focus of the regional debt crisis, with the country struggling to overcome recession and a costly banking sector restructure.
Yields on Spanish 10-year bonds have been trading above 7 percent, a level seen as too pricey for shaky public finances in the medium term by creating a self-full filling spiral like ones that have forced other euro governments to seek help.
The rise in Spain's longer-term interest rates put the sale of 3 billion euros (2.40 billion pounds) of bills in the spotlight ahead of a bond auction on Thursday.
There was good demand and the government met its target amount but the yield on the 18-month paper was the highest since November while the 12-month bill sold with the highest rate since before the birth of the euro.
"The yields are over 5 percent in both lines which is back at the levels we saw in November 2011 when the market was in huge distress and the ECB was forced to intervene," Credit Agricole rate strategist Peter Chatwell said.
Borrowing costs fell sharply after the European Central Bank flooded the market with around 1 trillion euros in cheap credit through two long-term refinancing operations (LTROs), in December and February, but they have since leapt back up.
Spain is hoping the ECB will ride to its rescue again. Officials have repeatedly said the central bank needs to take action to stop the euro zone debt crisis from getting worse.
On Tuesday, the Spanish Treasury sold 2.4 billion euros of the 12-month T-bill at an average yield of 5.074 percent, compared with 2.985 percent at the last auction in May.
It sold 639 million euros of 18-month paper at an average yield of 5.107 percent after 3.302 percent last month.
BAILOUT
Spain will face a bigger test in financial markets on Thursday when it auctions bonds maturing April 30, 2014, July 30, 2015 and July 30, 2017.
Spain's economy is under heavy pressure and earlier this month asked Europe for up to 100 billion euros to recapitalise its banking sector, suffering from a property market crash and a rise in bad debts.
The government was pleased to have avoided asking for a full-scale sovereign bailout such as the ones taken by Ireland, Greece and Portugal. But economists say the rise in borrowing costs and the worsening economic outlook may soon force it to seek fresh aid.
Spain entered its second recession since 2009 in the first quarter, and while it has barely grown at all since the property bubble burst in early 2009, most economists expect the economy to continue to shrink into next year at least.
Unemployment is over 24 percent, more than half all young Spaniards are out of work and deep spending cuts to tame one of the euro zone's largest public deficits are expected to prolong the downturn as investment plummets.
(Additional reporting by Claire Kane; Editing by Fiona Ortiz and Anna Willard)
