Sanchez, whose Socialists won an early general election last month but have yet to form a new government, had nominated Miquel Iceta, a veteran leader of the Catalan Socialist Party with a conciliatory position towards the separatists, to the post in what was seen as a goodwill gesture.
But the regional Catalan parliament on Thursday voted against Iceta's designation as a senator with 65 against, 25 in favour and 39 abstentions, thwarting Sanchez's plans to have him then appointed as speaker of the upper house.
It was the first setback for Sanchez since the April 28 general election which saw his Socialists win the most seats in Congress, the lower house, and obtain an absolute majority in the Senate.
Since the Socialists do not have an absolute majority in Congress, they need to negotiate an alliance with smaller parties in order to be sworn in for another term.
No agreements are expected before local, regional and European Parliament elections are held in Spain on May 26.
Deputy Prime Minister Carmen Calvo called the move to block Iceta's nomination “immensely clumsy”.
Iceta, a lawmaker in the Catalan regional parliament, has long called for a federal system of government in Spain in order to meet Catalonia's calls for greater autonomy and has repeatedly called for dialogue to resolve a crisis sparked by the northeastern region's failed bid to break away in 2017.
'Used to Madrid giving orders'
He has even suggested that Catalan leaders currently on trial in Madrid over the secession bid could be given a pardon.
But the separatists opposed Iceta's nomination because he and his party backed the temporary suspension of Catalonia's regional powers after the secession referendum and independence declaration.
They have also accused Iceta of not showing enough sensitivity to the Catalan leaders who are facing long prison sentences.
This is the first time in Spain's modern history that Catalonia's regional parliament has not simply ratified the choice for senator proposed by the top party in the upper house.
“You are very used to Madrid giving orders and Catalonia obeying,” said Albert Batet, spokesman for Catalan separatist party Junts per Catalunya, during debate in the Catalan parliament.
Conservative parties which fiercely oppose Catalan independence also abstained from voting on Iceta's nomination because they accuse him of being too soft on the separatists.