- Associated Press - Monday, June 11, 2012

LONDON — The weekend plan to rescue Spain’s ailing banks was supposed to boost confidence in Spain and the other 16 countries that use the euro. The skeptics said it would provide just temporary relief for the markets. In the end, it barely did even that.

Stocks and bonds surged in the first hour of trading Monday, a knee-jerk reaction to the weekend news that Spain would funnel up to $124.7 billion in loans to banks from its euro partners. But hours later, stock prices were back down, government borrowing costs were up, and bad economic news piled up across Europe.

Financial markets temporarily showed signs of relief that Spain’s banks, which have been dragged down by bad real estate loans, would receive an infusion of money. The country’s main stock-market index initially jumped nearly 6 percent, and the government’s borrowing rates fell sharply.

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But investors soon were overcome by a more familiar emotion: anxiety. They worried about whether Spanish banks would be able to repay the loans. If they can’t, the government is on the hook. It’s already having difficulty borrowing money at affordable rates in international bond markets, and this would worsen the situation.

Spain is in its second recession in three years; a quarter of its workforce is unemployed; and home prices keep falling, making banks even weaker.

By the end of the day, Spain’s Ibex stock index finished with a 0.5 percent loss. The interest rate on the country’s 10-year bonds rose to 6.47 percent, up from about 6 percent — a sign of investor nervousness about lending to Spain.

“We doubt that [this bailout] is the only support that the country will need,” said Jonathan Loynes, chief European economist at Capital Economics in London. “The poor economic outlook will also maintain concerns that Spain will at some point require a government bailout, too.”

Once it became clear that the rescue money for Spain’s banks would not solve that country’s problems, investors began worrying about one of its euro partners: Italy.

Italy’s economy is larger than Spain‘s. Italy didn’t suffer through a real estate bust, so its banks are in better shape. But like nearly half of the countries in the euro, it has a shrinking economy, making it difficult for the government to chip away at a mountain of debt.

Italy released data Monday that confirmed the country is in recession and has little likelihood of making a big recovery this year.

The government of Premier Mario Monti is trying to push through reforms to make the economy more competitive, but it’s facing opposition from unions and losing support from some key political parties.

Investors fear Mr. Monti may be forced to call early elections without having pushed through his economic reforms. The interest rate on the country’s 10-year bonds rose to 5.84 percent Monday, up from around 5.50 percent.

Also Monday, Cyprus acknowledged it was considering applying for an emergency loan package for its banks, similar to the one Spain sought.

The Cypriot government needs 1.8 billion euros by June 30 to give to Cyprus Popular Bank, the small island nation’s second-largest lender. It has for the past year relied on a Russian loan to pay its bills, but it will need more money in coming weeks to help the banks.

If it did ask for a European loan, Cyprus would become the fifth country in the currency union to seek outside financial help.

The government’s finances are in decent shape, and the economy is not in recession. Its problem, like Spain‘s, is the banks. Cypriot banks were heavily exposed to Greek government debt. They took huge losses on those investments when Greece wrote off about three-quarters of the value of its bonds in March as part of an international rescue package.

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