LONDON (Reuters) - Spanish bond yields hit a new euro-era high above 7 percent and Italian yields jumped on Monday as initial relief after a pro-bailout victory in Greek elections gave way to pessimism about the huge problems still facing the currency bloc.
The swift reversal in sentiment saw German Bund futures rise, quickly erasing more than a full point of early losses, while European equities and the euro wiped out early gains.
Political parties in favor of Greece's bailout lifeline began to try and forge a government on Monday after a narrow victory over radical leftists who wanted to tear up the existing aid agreement.
That removed the risk of an imminent Greek exit from the currency bloc, but the slim margin left major doubts over how effectively a pro-bailout coalition could govern, with markets taking the view that Greece may still end up leaving the euro zone.
"The Greek situation is still very, very precarious. They only just got the majority, but there are still a lot of headwinds there in terms of getting a coalition and then you've got Spain blowing up again - we're not in great shape," a trader said.
Investors turned their attention back to Spain, the euro zone's fourth-largest economy, where spiraling borrowing costs are threatening Madrid's ability to fund itself and raising speculation that Spain may need a full-blown bailout.
"I think we've moved on a bit from Greece to be honest. While it's undoubtedly important ... the bigger problem is 'How do you deal with Spain?' and there doesn't seem to be a satisfactory solution there," said Elisabeth Afseth, strategist at Investec in London.
Yields on 10-year Spanish bonds rose to 7.15 percent, up 23 basis points on the day. Greece, Ireland and Portugal were forced to seek international bailouts soon after their 10-year bond yields rose above 7 percent.
The cost of insuring against a Spanish default hit a record high of 612 basis points according to data monitor Markit.
Last week, a banking rescue deal worth up to 100 billion euros for Spain's troubled lenders sent the price of Spanish government bonds tumbling on fears that private creditors would be pushed further down the queue for repayment.
Italian debt also suffered, pushing yields up 15.5 bps to 6.08 percent, but the selloff was deeper in Spain, driving the yield difference between the two to 108 bps - the widest in the history of the euro zone according to Reuters charts.
German Bund futures were last 62 ticks higher at 142.91, after rapidly erasing early losses that saw the contract hit a low of 141.14 shortly after the open.
Concerns over Spain were likely to intensify ahead of a difficult auction due on Thursday as Madrid battles to maintain market confidence in its debt.
Spain is due to sell three short-dated bonds maturing between 2014 and 2017 on Thursday, and is expected to find sufficient demand to issue around 2 billion euros of debt.
"It seems to me as if the primary dealers and domestic banks and money managers all recognize that if they don't turn up to the auctions the game is over," said a head of trading at one primary dealer. "Consequently we continue to maintain access to capital markets for the periphery."
Dwindling international investor demand has forced Spain to issue small amounts of shorter-term bonds, which are cheaper to issue and attractive to domestic banks but shorten the country's debt profile, creating large redemption humps further down the road.
Spain also issues 12- and 18-month bills on Tuesday.
(Editing by Catherine Evans)