Spain raised €2.1 billion ($2.7 billion Cdn) Thursday from the bond markets — but investors demanded a higher interest rate out of concern that the country's troubled banks were weighing heavily on government finances.

Wednesday's bond sale saw strong demand for the country's 10-year bonds — about 3.3 times the amount on offer.

The Treasury paid an average interest rate of six per cent to sell €611 million in key 10-year bonds, up from 5.7 per cent in the last such auction April 19. The Treasury also sold bonds maturing in 2014 and 2016.

The rate is still lower than the 6.1 per cent being demanded on the secondary market, where issued bonds are traded openly and the rate is seen as an indicator of investor wariness.

However, some analysts said that the maximum amount sought by the Treasury in the auction — €2 billion — was so small it made the sale almost symbolic.

Later in the day, Prime Minister Mariano Rajoy appeared to abandon his insistence that the country's troubled banking sector will not need an external bailout, and for the first time avoided ruling out such an option.

And Germany, without mentioning Spain by name, also gave its clearest hint yet that it thinks Spain should tap the European rescue fund before its banks become too toxic to handle.

Rajoy said he would wait for the results of an IMF report next week and then two independent audits before announcing how much the banking sector might need for recapitalization.

Government awaits audits

"At that point I will give my figure and the government will say what the system needs to recapitalize itself," Rajoy told a news conference.

German Chancellor Angela Merkel said, after meeting with British Prime Minister David Cameron, that "considering the problems we are facing today, it is important to highlight once again that we have created the instruments necessary to support (countries) in the Eurozone, and that Germany is willing to apply these instruments whenever necessary."

She added, "this expresses our firm political will to stabilize the Eurozone, so that the Eurozone can contribute to stable economic growth worldwide."

Investors have demanded a higher interest rate to buy Spanish bonds out of concern that the country may not have the money needed to bail out its troubled banks.

The banks are saddled with billions in soured property investments following the bursting of the country's real estate bubble.

At the end of May, the most stricken lender, Bankia S.A., said it needed €19 billion in government aid to shore up its finances against losses on its toxic home loans.

But Spain only has €5 billion left in a €19 billion fund that it established in 2009 to help banks and has not mapped out a plan for raising the extra funds.

Estimates have put the cost of a complete bailout for the Spanish banking sector between €40 billion and €100 billion.

Rate soars as high at 6.7%

Spain would like to get European aid for its banks but is reluctant to ask for it because under current rules the aid would have to be given to the government. That would allow Brussels to dictate policies to Madrid, something the Spanish government is keen to avoid. It would also further hit investor confidence, sending interest rates on its bonds even higher.

The interest rate on Spanish debt has soared in recent weeks to as high as 6.7 per cent on fears over the country's creditworthiness. A rate of seven per cent is considered by market-watchers as unsustainable over the long term — and the point at which Greece, Ireland and Portugal had asked for a bailout.

The country has become the focus of Europe's debt crisis because bailing out the eurozone's fourth-largest economy would likely stretch the region's finances to breaking point.

However, there have been reports that European Union officials have been exploring ways to inject funds into the country's fragile banking sector without imposing strict conditions. The Financial Times said Wednesday that such a move could make the Spanish government less reluctant to accept international assistance.

Officials in Brussels are reported to have been looking at the conditions of the European Union's existing bailout fund, the European Financial Stability Facility. At a summit meeting in Brussels last July, EU leaders approved a measure allowing the bailout funds to lend money to recapitalize banks in countries that are not already receiving bailouts — such as Spain.

The money would have to be funneled through the government. But because the money is meant to help troubled financial institutions rather than the government, the conditions attached to the bailout loan would not have to be as over-arching as those attached to government bailouts, such as in Greece and Ireland.

Instead, according to the guidelines adopted in July, they could be "more focused."

However, the country in question would be ultimately responsible for repaying the loan, and would have to show that its economic policies are sound enough to allow it do to that.