Spanish and Italian Bond Yields Reach for the Skies on Political Woes

Plaza Mayor in Spain
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Plaza Mayor in Spain

As Spanish and Italian bond yields creep higher, strategists say yields could spike to the autumn 2011 levels that led to fears that Spain needed an imminent bailout.

On Monday, yields on Spanish 10-year sovereign bonds posted their biggest one-day rise this year, gaining 23 basis points to hit 5.40 percent. Italian bonds moved in tandem, with 10-year sovereign bond yields posting a 14 basis point rise to hit 4.47 percent.

"Even before 2013, market participants expected a riskier February, with many calling for a correction, as investors ramped up appetite for risk during January," wrote Joe Rundle, head of trading at U.K. trading platform ETX Capital, in a note on Monday afternoon.

Spain's bond yields have crept upwards since El Pais newspaper published corruption allegations against Spanish Prime Minister Mariano Rajoy and other senior members of his party, the Partido Popular (PP). Rajoy reportedly received regular cash payments of 25,000 euros ($33,875) from 1997 onwards, which were hidden from tax authorities.

(Read More: Spain's Mariano Rajoy Denies Corruption Charges)

Meanwhile, Italy is suffering political uncertainty ahead of its national election on February 24-25. Former Prime Minister Silvio Berlusconi – himself embroiled in multiple court cases regarding corruption – has gained in the polls in recent weeks, due to current technocrat leader Mario Monti's association with the unpopular Monte dei Paschi banking scandal.

(Read More: Monte dei Paschi Harbored Bank Within a Bank)

"The latest scandal in Spain will continue to unfold over the coming days, placing considerable pressure on the government's bond yields," said Rundle.

"At the same time, Italy's general election is likely to cap upside momentum for risk assets. The euro in that case is likely to ease further off its current highs as appetite for risk wanes."

Rundle forecast sustained pressure on Italian and Spanish yields would push the Spanish 10-year to 5.6 percent and the equivalent Italian to 4.8 percent.

"These are levels that had markets expecting an imminent bailout for Spain, and are likely to cause the same fear if yields continue to spike," he said.

Alastair Newton, senior political analyst at Nomura, agreed that political developments in either country could drive yields higher.

However, he said he saw no immediate serious threat to Rajoy's government.

"Barring something completely unexpected, the government is secure, even if it faces an even bumpier road ahead in the coming weeks," said Newton.

"We are still a long way from another full-blown euro zone-related crisis," he added.

Nonetheless, investors will watch with interest Spain's bond auctions on February 7 of 3.5 billion to 4.5 billion euros ($4.75 billion to $6.1 billion) of two-year, five-year and 16-year debt.

-By CNBC's Katy Barnato