Spanish debt yields rise as deficit problems mount By Nigel Davies and Andrei Khalip MADRID/LISBON (Reuters) - Spanish borrowing costs jumped at bond auctions on Wednesday, spreading fear in wider European markets and overshadowing a successful step back into debt markets by neighboring Portugal. Spain sold 2.6 billion euros of debt, at the low end of its target range, with a bond maturing in 2020 yielding an average 5.338 percent, up from a forecast 5.2 percent and 5.156 when it was last sold in September. Portugal sold 1 billion euros of 18-month T-bills, its longest dated debt since the European Union and International Monetary Fund bailed the country out, with a 4.537 percent yield, compared with 5.993 percent shortly before the rescue. Concerns Spain will struggle to meet tough deficit targets and treat its ailing banks as the economy slows have hampered its debt issuance plans and fuelled concern it might be forced to follow Greece, Ireland and Portugal in seeking a bailout. Spain has become the focal point for investor anxiety about the euro zone. This is a bout of investor nervousness, the severity of which is difficult to ascertain at this point," said Nicholas Spiro at Spiro Sovereign Strategy. European shares extended their losses after the auction and the cost of insuring Spanish and Italian debt against default rose. Spanish yields rose on the secondary market, where the key 10-year bond was up around 25 basis points close to 5.7 percent. Yields on 10-year debt had fallen as low as 4.6 percent in late January as cheap European Central Bank cash aided a rally in weaker periphery state debt. Concern over the Spanish auction also helped drive the euro to a three-week low versus the dollar. The auction in Portugal, which Finance Minister Vitor Gaspar called "a successful bet" encouraged investors, but failed to quash doubts Lisbon could finance itself fully in the commercial debt market from the second half of 2013 as its bailout deal envisages. Madrid's debt sales were still supported by a wave of cheap three-year funds provided by the ECB in December and February, but rising yields showed support waning. A tough budget presented on Tuesday, including 27 billion euros of savings, did little to assure investors the country will be able to meet its deficit obligations. Earlier data showed the country's dominant services sector contracted for the ninth consecutive month in March, highlighting the likelihood that the economy fell back into recession in the first quarter for the first time in three years. Spain is at least ahead of the curve, having completed 47 percent of its debt issuance plans for the year in a little over three months. Its heavy sales in the first quarter of the year could well prove significant if bond sales continue to sour. The average yield of a bond maturing in 2015 was 2.890 percent, up from 2.440 percent when it was last sold on March 15, but below analysts' expectations of around 3.1 percent. A 2016 bond, however, yielded 4.319 percent after 3.376 percent a month ago and analysts' expectations of 3.95 percent. Portugal fared well as it took a gentle step in selling its longest dated debt since its bailout. The IGCP debt agency also sold 500 million euros in 6-month T-bills at an average yield of 2.90 percent, sharply down from February's 4.332 percent. The total amount of T-bills sold in the auction was at the top of the indicative offer range. Demand outstripped the amount placed by 2.6 times on 18-month bills and 5.0 times on the 6-month maturity. "It was a successful operation at a time when the effects of ECB's liquidity injections are starting to wane in the debt markets," said Duarte Caldas, market strategist at IG Markets brokerage in Lisbon. Yields in T-bill placements have fallen steadily over the past couple of months, allowing Portugal to increase the amounts and lengthen the maturities of its T-bill issues. Gaspar said lower yields and growing interest from local and foreign investors in the past two months have provided "gradual signs that the T-bills could be used in the process of transition to the normal access to the bond market." Still, most investors say Portugal, which is in a deep recession, may need additional rescue funds, and some even express fear of a Greece-style debt restructuring. ($1 = 0.7497 euros) additional reporting by London government bonds desk; editing by Philippa Fletcher