MercoPress. South Atlantic News Agency

Germany ready to bail out Spain; sovereign rating down to BBB negative outlook

PM Rajoy waiting for the results of an independent audit of the banking system

German Chancellor Angela Merkel said Europe was ready to act to ensure stability in the Euro zone as Spain's credit rating was cut by three notches amid expectations it may soon seek EU help for banks beset by bad debts.

Spanish Prime Minister Mariano Rajoy said he would wait for the results of independent audits of the banking system before talking with Europe about how to recapitalise troubled lenders.

An International Monetary Fund report due out next Monday is expected to show Spanish banks need at least 40 billion Euros, financial sector sources said.

Without waiting for a widely expected EU rescue, credit ratings agency Fitch cut Spain's sovereign rating to BBB from A with a negative outlook, saying Madrid was especially vulnerable to a worsening of the euro zone debt crisis.

Fitch estimated Spanish lenders need 50 to 60 billion Euros in capital under their updated base case. However, the total fiscal cost to underpin the banks could rise as high as 100 billion Euros or 9% of GDP in a more extreme scenario similar to Ireland's bank meltdown, it said.

Speaking after talks in Berlin with British Prime Minister David Cameron - who called for “urgent action” to tackle the debt crisis - Merkel said Germany stood ready, alongside the other 16 Euro zone countries, to do whatever was necessary.

“It is important to stress again that we have created the instruments for support in the Euro zone and that Germany is ready to use these instruments whenever it may prove necessary,” she said, referring to the Euro zone's temporary bailout fund, the EFSF, and to its permanent successor, the ESM.

If Spain does decide to seek help with recapitalising its banks, laden with bad property debts and other underperforming loans, it is expected to ask for funds from the 440 billion Euro EFSF or the 500 billion Euro ESM, due to be operational in July.

Despite the pressure, Spain demonstrated it could still tap credit markets, raising all the money it required, although at a higher cost. Madrid sold 2.1 billion Euros of government bonds, paying just over 6% for 10-year debt - up from 5.74% last month and the highest at auction since 1998.

The sale laid to rest - at least for now - fears raised by Treasury Minister Cristobal Montoro on Tuesday that Spain was being shut out of credit markets.

In the midst of the storm, Spain nominated a new central bank governor, Luis Maria Linde, aiming to restore the Bank of Spain's credibility, battered by its handling of the banking crisis. He was preferred to outgoing European Central Bank executive board member Jose Manuel Gonzalez-Paramo.