BOND investors reacted with horror to the latest changes to EU bailout rules by dumping Irish and other risky bonds yesterday, driving borrowing costs for Ireland to a fresh high.
European finance ministers have agreed new rules that mean a government accepting rescue loans from 2013 can be forced to inflict losses on its bondholders in exchange for aid.
The Irish Government's cost of borrowing over two years surged to 10.18pc yesterday, the highest yield since 2003, and higher than the cost of 10-year borrowing.
Under the new European Stabilisation Mechanism (ESM), a country needing a bailout after mid-2013 will "be required to engage in active negotiations . . . with its creditors".
"It means default -- imposing losses or extending repayment times on bondholders to protect the taxpayers providing the rescue. Seeing that in black and white really focused people's minds yesterday," said Elizabeth Afseth of Evolution Securities.
The extreme market reaction provoked talk that an Irish bank had missed a debt repayment. The rumour was eventually scotched by both AIB and NTMA. "There were other rumours around but it was the ESM Term Sheet that caused the market chaos," Ms Afseth said. In reality, the sell-off came because investors fear holding bonds due to be repaid after the current bailout ends.
"Ireland's bailout ends in two and a half years and we are no closer to getting back to normal borrowing, so it's no surprise investors are concerned about the ESM," said Dermot O'Leary of Goodbody Stockbrokers.
Indeed, the irony is that investor fears of getting caught in the new ESM regime makes it harder for Ireland or Greece to get back to the market, and more likely Ireland will end up inside the ESM.
Most investors had previously assumed that only investors lending after the change of regime in 2013 would suffer losses under a future bailout.
A spokesman for the EU Commissioner Olli Rehn appeared to strongly rule out any unilateral default by countries in receipt of EU assistance.
Amadeu Altafaj said that under the ESM talks to restructure a nation's debts would only begin after an analysis had been done on whether the debts were sustainable or not.
Banking crisis, pages 46/7