European shares hit a 15-week high and the euro rose against the dollar on Thursday as strong US corporate profits boosted sentiment, but a rise in Spanish borrowing costs rekindled fears that a full sovereign bailout was becoming inevitable.
US stock index futures pointed to the gains in equities continuing on Wall Street, where the earnings season is in full flow.
On the oil markets, Brent crude rose above $106 a barrel to a seven-week high as violence in Syria and an attack on Israeli tourists increased tension in the Middle East, bringing supply concerns back into focus.
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The biggest threat to a resumption in demand for riskier assets was the rise in Spain's borrowing costs, which hit new euro-era highs for five-year debt at a 3 billion euro auction of new bonds.
“The risk is that yields could start rising also in shorter maturities, where Spain is doing most of the funding, and that will basically be game over for Spain,” said Gianluca Ziglio, a strategist at UBS.
The sharp fall in demand for Spain's bonds and the big rise in costs the government has to pay to fund itself comes despite Madrid's efforts to cut the budget deficit and tackle the problems in its banking system.
10-year Spanish government bond yields in the secondary market climbed back above seven per cent after the auction, with the spread versus German debt, seen as the least risky euro zone asset, close to record highs at 582 basis points.
A 10-year bond yield of over 7 per cent, as happened with Greek, Portuguese and Irish sovereign debt, is a level many analysts consider to be unsustainable.
“The real issue here is that markets are not giving Spain the benefit of the doubt,” said Charles Diebel, head of market strategy at Lloyds Bank Corporate Markets.
“The odds are certainly going up that Spain may have to request direct intervention in its bond market,” he said.
The main Spanish share index, the IBEX, turned negative after the sale but recovered to be up 0.8 percent, in line with gains in other European markets.
Spain should receive some good news later in the day when the German parliament votes on the rescue programme for its troubled banks, which should then pave the way for a formal approval by euro area finance ministers on Friday.
FRANCE FUNDS
In contrast to Spain, French borrowing costs plunged at an 8.96 billion euro sale of bonds maturing in 2015, 2016 and 2017, with two-year yields running at near zero.
France is benefiting from demand for the debt of the euro zone's best-rated sovereign issuers after the European Central Bank cut its overnight deposit rate to zero earlier this month.
In the wake of the ECB's move, French bonds have rallied strongly, with the premium investors require to hold 10-year French bonds over their German equivalent falling 25 basis points so far this month.
The euro fell to a day's low of $1.2263 after the Spanish auction result before settling to be little changed on the day at $1.2285.
However, the ECB rate cuts did see it touch fresh lows against the yen and the Australian and New Zealand dollars.
DOLLAR DIPS
The US dollar was also weak, mainly because the Federal Reserve Chairman Ben Bernanke had kept alive talk of more monetary easing in the second stage of his testimony to the US Congress on Wednesday, though he played down the risks of a double-dip recession.
The dollar fell to a two-week low against a basket of currencies, with the dollar index hitting 82.70, and traded at a six-week low against the yen.
In equity markets investors stayed focused on the second quarter earnings season and the outlook for corporate profits.
The FTSEurofirst 300 index of top European shares was up 0.7 per cent at 1,061.75 points and on track for a seventh straight week of gains.
“There have been some good company results, which have lifted sentiment. But I don't think investors have been complacent as the euro zone situation is still in the background,” saidKeith Bowman, equity analyst at Hargreaves Lansdown.
Most of the good news on corporate profits has emerged from the United States, where, of the 63 companies in the S&P 500 index to report second quarter earnings so far, 71.4 per cent have beaten analysts' expectations, 11.1 per cent have been in line with forecasts and only 17.5 per cent have fallen below estimates.
The positive numbers, which have included many big name tech companies such as Intel Corp and Honeywell, sent the S&P 500 to its highest level since early May on Wednesday, helped also by some good news on house building.
The gains spilled over into Asia, helping send the MSCI world equity index up 0.6 per cent to 314.45 points.
Oil market gains were capped by data from the Energy Information Administration (EIA) on Wednesday showing crude stocks in the United States fell less than expected last week as crude imports rose and refineries scaled back processing rates.
Gold took its cue from the weaker dollar, though investors were less than convinced of its direction, given the uncertainty over Fed stimulus measures and persistent worries about Europe.
Spot gold gained around 0.5 per cent to trade around $1,580 an ounce.
Copyright @ Thomson Reuters 2012
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