(Corrects to say Spanish CDS highest since June, not March)
By Claire Milhench and Helen Reid
LONDON, Oct 4 (Reuters) - Spain's deepening political crisis drove up the cost of insuring exposure to Spanish sovereign and bank debt to multi-month highs on Wednesday and rippled out to Italian and Portuguese credit default swap (CDS) markets.
The leader of Catalonia, the region which held an independence referendum on Sunday, has pledged to declare independence in "days", plunging Spain into its worst constitutional crisis in decades.
The referendum has been declared illegal by Spain's government but the uncertainty has driven up yields on government bonds to the highest since March, slammed Madrid's stock markets and fuelled a surge in sovereign CDS.
CDS are derivative contracts commonly used by investors to hedge against the risk of default or restructuring by a borrower. A rise in CDS indicates that markets assign higher risk of the entity being unable to meet its obligations in future.
Spain's five-year sovereign CDS have risen to the highest since June, inching up two basis points on Wednesday to 73 basis points, according to IHS Markit data.
This means it costs roughly 73,000 euros a year to insure exposure to 10 million euros worth of Spanish debt for a five-year period.
Spanish CDS traded as low as 54 bps on Sept 19.
Banks based in Catalonia are caught up in the tremors - five-year CDS for the Catalonia-based Caixabank rose 2 basis points (bps) from Tuesday's close to 76 bps, the highest since mid-July.
CDS of Banco Sabadell, also headquartered in Catalonia, were at a one-month high of 75 bps, Markit said.
"CDS are going up because of perceptions of risk, so that would have implications for cost of equity from an equity investor’s point of view as well," Benjie Creelan-Sandford, Spanish banks analyst at Jefferies, said.
Caixabank is Catalonia's largest lender, and the country's economy minister has reassured bank customers that their deposits are secure from the growing crisis.
However, investor nerves have hit both banks' bonds. The yield of Caixabank's 2023 bond for instance rose to a record high while Banco Sabadell saw yields on its 2026 bond rise to above 3.8 percent for the first time in more than two months.
Creelan-Sandford noted however that CDS on the banks remained well below where they had been early in 2017 while share prices for Caixa and Sabadell were still around 20 percent higher on the year.
"Throughout this year the Spanish economy has been continuing to do extremely well, and the banks have been big beneficiaries of that," he said. "The move that we have seen today in banks’ CDS is very small in the context of where we have seen CDS historically."
Still, the crisis is starting to impact other southern European states, pushing up bond yields in the region.
Markit data showed Italy's 5-year CDS 4 bps rising four bps to 145 bps, the highest since end-August. It ended last week at 138 bps.
Portuguese 5-year CDS rose 2 bps to 146 bps, the highest since mid-September and Spain's CDS rose 2 bps to 73 bps, a five-month high.
Analysts say there could be more pain to come for asset prices in Spain and southern Europe. Catalan business lobby Cercle d'Economia said it was extremely worried by the prospect of Catalonia declaring independence and warned of "very serious consequences" for the region.
"Spanish bonds continue to underperform versus their peers and we think there will be another leg wider should the Catalan Leader declare independence," Nomura analysts told clients. (Reporting by Claire Milhench, Helen Reid, Dhara Ranasinghe and Karin Strohecker; Editing by Sujata Rao and Matthew Mpoke Bigg)