With Spain looking increasingly likely to miss this year's deficit target, credit rating downgrades for several of its regions, and its borrowing costs showing an uptick things aren't getting any better for the country, with one analyst telling CNBC that the country is caught in a "vicious circle".
Bloomberg
Spanish newspaperEl Confidencial reported on Tuesday that the central bank had written to the European Union explaining that Spain's government is due to miss its deficit forecast for this year, which currently stands at 6.3 percent ofgross domestic product (GDP).
TheSpanish economyalso contracted in the third quarter by 1.7 percent year-on-year the government reported on Tuesday, compared with a 1.3 percent contraction in the second quarter.
"Spain is trapped in a vicious circle", Nicholas Spiro, Managing Director at Spiro Sovereign Strategy told CNBC.com.
The country's sizeable debts, the vulnerability of its banks and the weakness of its public finances are all feeding on each other, according to Spiro. Spain has embraced practically all the reforms being demanded of it, he says, but the underlying creditworthiness continues to show no signs of improvement.
A bond auction for short term paper on Tuesday morning proved a mixed bag for the Spanish treasury. Demand outstripped supply with the yield on six-month debt falling to 2.023 percent from 2.213 percent. However, the yield on three-month bills rose to 1.415 percent from 1.203 percent, with the benchmark 10-year bond yield also rose on Tuesday to 5.544 percent from 5.468 on Monday.
Spiro believes that investors can end up reading too much into bond auctions, but in Spain's case the bond sales can be used to gauge underlying sentiment, with the lower bond yields a reflection of theEuropean Central Bank'sbond-buying program.
"It's nothing to do with Spain, it's driven by the perceived credibility of the ECB's fiscal backstop," he told CNBC.com. "In many ways it's a microcosm of the almost schizophrenic-type sentiment to Spain now."
"It's a glaring example of the disconnect between central bank driven liquidity and the domestic underlying fundamentals. The more striking this disconnect becomes the more likely it is that we're going to get a much more pronounced uptick in Spanish yields."
Richard McGuire, senior fixed income strategist at Rabobank believes that a bailout request from Spain is on the horizon, but not in the next few weeks as some analysts have been speculating.
"Our view is it will come before the end of the year — it's somewhat a moot point. There's certainly a debate on that front. Many of our Spanish clients think it's more of a question for next year, than this year," he said.
"I think that the key point is though that Spain needs to come under pressure before it asks for a bailout, it cannot ask for a bailout willingly, because of the political fallout from asking for a bailout will be magnified if Rajoy makes the request whilst Spain can still somewhat relatively, comfortably access the private markets."
The news was bad for Spain even before Tuesday's GDP data, with credit ratings agency Moody's downgrading the five regions of Andalusia, Extremadura, Castilla-La Mancha, Catalonia and Murcia on Monday evening.
Moody's said the decision was "driven by the deterioration in [the regions'] liquidity positions, as evidenced by their very limited cash reserves as of September 2012 and their significant reliance on short-term credit lines to fund operating needs."
Rabobank's McGuire said this isn't a surprise.
"I think this just underlines the threat that the regions pose to the center and the importance of ensuring that Rajoy can bring the so-called autonomous regions back under control in terms of bringing them to heel fiscally," he told CNBC Tuesday.
Regional elections on Sunday brought mixed news for Prime Minister Rajoy, with gains for his own political party as well as for Basque separatists in the north of the country.
"These independence movements make it harder for Rajoy to put pressure on the regions to make sure that they toe the budgetary line," McGuire told CNBC
"It will take time and also it's a politically fraught exercise."
Thousands of people are expected to attend a protest outside Parliament in Madrid on Tuesday evening as politicians debate Spain's 2013 budget spending cuts.