2012.06.08 10:39:44 *ECB's Nowotny: Spanish Banks Are Problem, Not Economy

Spanish government bonds fell in early trading Friday after Fitch Ratings cut the country's credit rating by three notches, souring recent optimism that euro-zone leaders are inching closer to a rescue package for Spain's beleaguered banking system. Fitch Thursday lowered its long-term issuer default rating on Spain to triple-B, two steps above junk grade. The ratings agency estimated the recapitalization needs of Spain's banks at EUR60-100 billion, ramping up the pressure on Spanish sovereign debt at a time when the government is struggling to bring its budget deficit under control. Spain is also vulnerable to contagion as the Greek election looms, bringing with it fears of a potential euro-zone break-up. Spanish government bonds sold off sharply early Friday, while Italian bonds were also hit by the latest reversal in euro-zone sentiment. Spanish 10-year yields climbed by eight basis points to 6.11%, while the equivalent Italian yield was eight basis points higher at 5.74%, according to Tradeweb. German Bunds benefited from the resulting flight to safety, pushing 10-year yields five basis points lower to 1.32%. The moves followed two days of relative calm in bond markets, as Spanish and Italian yields eased on hopes that Germany's opposition to using the euro zone's bailout funds to recapitalize Spanish banks was softening. "From the past two days' price action, we think that markets are getting ahead of themselves especially with the Greek election in just over one week's time," said interest rate strategists at the Royal Bank of Scotland Group PLC. Precautionary support of Spanish banks by the European Stability Mechanism--the euro zone's permanent rescue fund--is unlikely to stave off eventual full ESM support for Spain and halt the slide of its sovereign rating into junk territory, they said. -Write to Tommy Stubbington at tommy.stubbington@dowjones.com (END) Dow Jones Newswires June 08, 2012 04:40 ET (08:40 GMT)