Almost a third of European junk bonds are trading at distressed levels, and analysts reckon a wave of defaults are on the way as companies fail to make their repayments on debts.

Junk, or high-yield, bonds are among the riskiest bond investments, as they are issued to fund small companies or those with high-risk profiles.

Billions of pounds' worth were issued during the years of the bull market to fund private-equity buyouts of companies.

Investors are now demanding far more in return for taking on junk bonds.

So nervous are they of defaults, that on average, they are insisting on receiving 12.3% more yield on junk bonds than they would get on government bonds. Any such spread above 10% means the bond is considered "distressed".

"Those levels of distress would indicate that defaults are going to rise," Gartmore Investment Management's Karl Bergqwist told Bloomberg.

"We think there's much worse to come. Spreads could go a lot wider and defaults are undoubtedly going to go up."

The number of bonds trading on extra yields has not been this high since the dot-com bubble burst.

Ratings agency Moody's says defaults on European speculative-grade corporate bonds will climb to 2.3% in a year, from around 0.7% now. Globally it puts the likely default rate at 7.4% from 2.7% now.

Investors have fled to quality in the fallout from the subprime mortgage crisis and the credit crunch that flowed. Europe's high-yield bond market has contracted dramatically since July last year when the turmoil began.

In 2007 companies used junk paper to borrow $32.1billion (£18.31billion) but only $5billion of that was raised in the second half.

Standard & Poor's has echoed Moody's warnings. Levels of distress are “a leading indicator of future speculative-grade defaults with a lead time of roughly nine months”, S&P analysts wrote in a report published last month.

"A rising distress ratio is indicative of a stressful credit environment," the rating agency said.