An expected bailout for Spain's government may be a gamble that it would be enough to keep the debt crisis bull's-eye away from too-big-to-fail Italy. But it could backfire.
Bond yields for Spain and Italy have moved up and down together, as escalating worries over Spanish deficits and bank solvency pulled up Italian rates.
"If Spanish pressures are down, it would be good for the entire eurozone," said Ludovic Subran, chief economist at Euler Hermes. "Italian yields are extremely bizarre. It's really due to the pressure on Spain.
That may be why Italian Prime Minister Mario Monti reportedly urged Spanish counterpart Mariano Rajoy at a recent meeting to seek international aid. Italian officials have repeatedly denied needing their own bailout.
Subran agrees, saying Italy's banks are in better shape than Spain's and can help the economy grow again if labor, tax and regulatory reforms continue.
"The country by itself can get out of this mess," he said.
All Bailouts Lead To Rome? But a Spanish rescue that isn't paired with a similar one for Italy would likely ramp up pressure on Rome, said Bill Adams, senior international economist at PNC Financial Services.
"If Spain gets pushed into a bailout, I would expect markets to look to Italy next," he said, noting that Italy and Spain both suffer from high debt, contracting economies and inefficient labor markets.
While they have made progress on labor reforms, improved economic growth may not come for years. "Meantime, these countries are in serious trouble," he said.
The trouble is now severe enough that Spain is expected to formally ask for a sovereign bailout as soon as next month. Pressure could intensify further in September if Greece doesn't show enough progress on its bailout conditions and risks getting booted from the eurozone.
A Spanish rescue became more likely after European Central Bank President Mario Draghi indicated ECB purchases of sovereign debt, long hoped for by Madrid, wouldn't happen until a request came first.
But Spain is still seen issuing debt on capital markets at the same time as it receives international aid.
Draghi hinted the ECB may be willing to take losses on any bonds it buys, allowing private investors to continue buying debt without worrying they would bear nearly all the burden in the event of a default.
Retaining market access would lessen the tab for Spain's rescuers, who have already committed up to 100 billion euros to backstop its banks. But eurozone money is running out, leaving the ECB to pick up more slack.
In June, the Institute of International Finance said Europe's bailout funds have 251 billion euros left after the still-pending Spanish bank rescue. That was before Cyprus sought aid, which could exceed 10 billion euros.
Subran estimates Spain's government needs 60 billion-80 billion euros in international aid over the next three years to help it meet deficit targets.
A deepening recession has already forced Spain to push back deficit-reduction goals. Its 2012 deficit target has shifted to 6.3% of gross domestic product from an earlier one of 5.3%. The goal for next year has risen to 4.5% from 3%.
Spain's bailout request may not come with an exact number, and how much post-rescue market access it will have is unclear, said PNC's Adams.
But the trillions of euros in financing needs for Spain and Italy in coming years are so large that any bailouts would have to be supported, directly or indirectly, by the ECB.
"Realistically, you would need ECB backing," he said.