Eurozone Bond Spreads Widen as Debt Burden Fears Heightened

Fears of rising interest rates has been revived as the Eurozone bond spreads widened sharply on Monday. The interest rate hikes simply imply that the debt burdens of individual member states in the currency union may be too big to service. 

Last week, the European Central Bank (ECB) said it is likely to raise its deposit rate by 25 basis points in July and warned that a larger increase in September would be necessary unless the outlook for inflation improve.

To recap, the print inflation rate has hit its highest level in May in 23 years since the euro’s creation. 

Just as when the Frankfurt-based Central Bank is planning to hike up interest rates when economic growth is stunted as a result of the war in Ukraine and many member states’ public finances in severe trouble as a result of pandemic, forcing the EU to suspend its normal budget rules. An untimely interest rate hike now poses severe threats to saddle governments with increased debt servicing costs at a time when they can ill afford it. 

Two countries stand out in this regard – Italy and Greece. Italy, because it has the Eurozone’s third-largest economy and the region’s biggest debt load at over 2.6 trillion euros as of the end of 2021; While for Greece, because of the extraordinarily high debt-to-GDP ratio it was left with after two major restructurings a decade ago still left it with a massive debt relative to the size of its economy. 

The European Commission estimated that Italy’s gross public debt stood at 150.8% of GDP, while the comparable ratio for Greece stood at 193.8% as of 2021.

Other Eurozone economies that have debt ratios well over 100% of GDP as a result of the pandemic are Spain and Portugal. 

The ECB has been an active buyer of these countries’ bonds for almost all of the last seven years, helping to soothe fears about debt sustainability through its policy of quantitative easing. However, the bank said on Thursday that it would end QE at the start of July, leaving markets to determine the real price of Eurozone sovereign debt. 

The markets’ answer has been to sell bonds from the region’s so-called periphery, with increasing eagerness.

Indeed, the selling has accelerated in the wake of the ECB’s press conference last week, where President Christine Lagarde was unable to give any detail about a rumored new tool being planned for keeping the premium paid by weaker credits over the German 10-Year within acceptable limits. That has now blown out to 231 in the case of Italy and over 260 in the case of Greece. 

The yield on the benchmark Italian 10-Year bond rose to a nine-year high of 4.10% on Monday, having traded below 1% as recently as October. Greece’s 10-Year benchmark has risen from at little as 0.83% to 4.39% in the same time. 

The euro itself, meanwhile, hit its lowest in six years against the dollar last week ion fears that a series of ECB rate hikes would tip the Eurozone into recession later this year. It was broadly stable late Monday in Europe at $1.0488.

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