Wednesday 7 December 2016

Is the ECB the only thing keeping Europe from another sovereign debt crisis?

Mehreen Khan

Published 12/02/2016 | 08:36

Share traders dressed in a carnival costumes work a their desks ar the stock exchange on Shrove Tuesday in Frankfurt, Germany February 9, 2016. Frankfurt's bourse traders follow a long tradition by wearing carnival costumes on Shrove Tuesday. REUTERS/Kai Pfaffenbach
Share traders dressed in a carnival costumes work a their desks ar the stock exchange on Shrove Tuesday in Frankfurt, Germany February 9, 2016. Frankfurt's bourse traders follow a long tradition by wearing carnival costumes on Shrove Tuesday. REUTERS/Kai Pfaffenbach
‘We have the determination, and the willingness and the capacity of the Governing Council, to act and deploy these instruments,’ ECB president Mario Draghi told the World Economic Forum. Photo: Ruben Sprich/Reuters

In echoes of the eurozone's 2011 crisis, the "safest" European government debt is plummeting, while perceived "riskier" sovereigns are seeing their borrowing costs spike.

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Portugal, a former eurozone bail-out nation, saw yields on its 10-year debt rise to their highest level since 2014 on Thursday.

Portuguese 10-year paper soared to 4.074pc - its highest level since the country exited an international rescue programme in the summer of 2014. Italy's 10-year debt rose to 1.699pc, its highest level since November, while Spain's bonds have soared 25 basis points in February alone.

Meanwhile, German bunds, along with US and UK debt, are plummeting to record lows as investors scramble around for haven assets.

So is another repeat of the 2012 euro debt crisis on the cards?

Peripheral euro debt markets have been pretty uneventful since the European Central Bank launched its unprecedented bond-buying programme at the start of 2015.

The ECB's €60bn-a-month asset purchases have kept a lid on borrowing costs in the most vulnerable member states - namely Portugal, Spain and Italy.

Things seemed so rosy that back in November, Lisbon issued six and 12-month debt at a record negative yield, once again reflecting that investors saw Portugal - which has the highest combined debt burden in Europe - as safe a bet as Germany. Today's bond market ructions are still nothing like the soaring debtor distress of five years ago, but do reflect mounting concern that the debt piles and public finances of the euro's weakest member nations are still not in good shape.

Portugal is particularly vulnerable to these scares. The country is now ruled by a left-wing coalition that has promised to roll back on Brussels' austerity demands, and bring some life into its moribund economy and beleaguered banking system.

Lisbon's 2016 budget is at "serious risk" of non-compliance with the EU's debt and deficit rules, the European Commission has warned.

Adding to the mix, Portuguese government debt is perilously close to being downgraded to "junk" by all but one of major credit ratings agencies. Only one recognised ratings body - DBRS - thinks Portuguese government debt is of investment grade quality.

Should Lisbon lose its investment-grade rating, today's debt market murmurs could develop into full-blown contagion.

By the rules of the ECB's QE programme, in the event of a "junk" rating, Portuguese debt would no longer be eligible for purchase under its quantitative easing (QE) programme or the central bank's landmark "Outright Monetary Transactions" scheme.

"The only way to prevent this is for Portugal to sign up to a new bail-out program, even if its a precautionary credit line rather than a full bail-out," said Federico Santi at political risk consultancy Eurasia Group.

"Needless to say, this is politically very toxic, and something the government would do only as a last resort."

Much like the last time the world began to panic about the state of eurozone's credit markets, all eyes are again on the ECB president Mario Draghi.

"Ultimately it is only the ECB that is holding Europe together," says David Folkerts Landau, chief economist at Deutsche Bank.

"Outright Monetary Transactions and QE makes government debt sustainable. If the ECB was to step back from that you would have a massive sovereign debt crisis."

Exactly four weeks from now, the Italian is widely expected to announce a new round of inflation-busting measures. They are expected to include the further slashing of interest rates and extension of government bond-buying, to once again assuage jittery investors and bring Europe back from the brink.

Telegraph.co.uk

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