Spain's borrowing costs soared on Wednesday to reach their highest level since the country joined the euro, close to levels where other debt-stricken countries such as Greece and Ireland have asked for an international bailout.
Concerns over Spain's nationalised lender Bankia, and the government's ability to come up with a Euro 19 billion rescue package for the bank, have sparked the latest round of investor fears over the country.
The interest rate - or yield - on Spanish 10-year bonds, a key indicator of market confidence in a country's ability to pay down its debt, shot up 25 basis points to 6.67 per cent - matching the level it hit at the height of the eurozone crisis late last year. The yield later fell back to hit 6.66 per cent in afternoon trading.
A yield of 7 per cent is seen by many analysts as unsustainable for a country to continue financing itself over the long term. Meanwhile, the difference between the Spanish bond and the equivalent safe-haven German bunds was a record 5.36 percentage points.
The country's conservative government has introduced harsh austerity measures, including spending cuts on health and education, in an attempt to control the level of its debt relative to the size of its economy.
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It is also trying to reassure investors worried that the woes of the banking sector will force the country to require a bailout like those take by Greece, Ireland and Portugal.
Spain's banking industry has been saddled with a large amount of unpaid, so-called "toxic", loans on their books following the collapse of the country's real estate bubble in 2008. There is a concern that Spain's government will not be able to find the funds to prop up the sector and keep its economy afloat.
Earlier, the government vehemently denied newspaper reports that the European Central Bank had rejected a Spanish idea to finance a bank bailout and it defended the country as sound.
The Financial Times reported on Wednesday that the ECB rejected the idea of Spain paying for the Euro 19 billion bailout of struggling nationalised lender Bankia by using government bonds, which would then be used as collateral for cash from the ECB.
Economy Minister Luis de Guindos, speaking to opposition Socialist lawmakers during a debate in Parliament, denied the report.
"Pay more attention to the Spanish government and less to the Financial Times." De Guindos said. "The government of Spain has not presented any plan to the European Central Bank, nor has the European Central Bank rejected anything in this regard."
Speaking later to reporters in what seemed an impromptu and desperate effort to talk the bond spread down, de Guindos noted that Italy's yield on its 10-year bonds were also sharply up on Wednesday.
The minister defended the government as transparent on what it plans to do with the banking sector, heavily laden with billions of euros in toxic assets after the implosion of a real estate bubble. New provisioning requirements to the tune of Euro 84 billion have been ordered, two independent audits of banks' loan portfolios will take place, and an IMF report will come out in June.
"We will shine the light on what the consequences of the financial crisis have been for the banks," de Guindos said.
He said Spain's bond spread - at over 530 points now - are "not very sustainable over the long term" - will come down once uncertainty over the Greek political situation is resolved. A recent election there failed to produce a government amid discord over EU-mandate austerity that came along with a mountain of bailout money.
De Guindos also insisted that the Spanish treasury is "perfectly well financed" and that aside from money for bond redemptions it needs to carry out just Euro 3 billion in net debt issuance from now to the end of the year.
The European Central Bank issued a statement saying that it had not been consulted about Spain's recapitalisation plans for Bankia and had not expressed a position about them. The statement said the ECB "stands ready to give advice on the development of such plans."
Spain's Ibex 35 stock index was down about 1.53 per cent at 6,156.
The European Commission is due to set out its annual economic strategy report Wednesday, when it will issue recommendations for each of the 27 European Union members - including Spain.