Friday 23 February 2018

Eurozone crisis: Why is the 7pc bond yield important for Spain?

Amy Wilson

SPANISH bond yields today climbed to 7pc, after Moody's cut the country's credit rating and warned Spain's government debt could be relegated to non-investment grade status within three months.

What are bond yields?

Governments raise money to pay for public services and benefits through taxes, but also by borrowing money in the markets. Those government debts are issued in the form of bonds.

The yield is the interest rate on the loan, or bond, ie. how much the government has to pay to the bank, institution or country which has bought its bond and loaned it money - in the same way individuals have to pay interest on a mortgage or bank loan.

Why do yields go up or down?

Bond yields are linked to the price. When more people want to buy a bond (ie. lend money to a country), then the price goes up in the same way a share or house price goes up when more people want to buy it.

When the price goes up, the yield goes down - if lots of people want to buy the government bond it means it is viewed as a good risk and therefore the government doesn't have to pay as much in the way of interest to get banks or other countries to lend to them.

However when the price goes down because investors become more reluctant to lend to that country, then the yield goes up - the government has to pay a higher interest rate to persuade banks or countries to lend to them.

Why does it matter if Spain's bond yields are higher than 7pc?

In Spain's case, paying a 7pc interest rate to borrow new money means it becomes extremely expensive for the country to pay for its public services and service its debts.

The country could find itself in the position of borrowing more money just to make its interest payments - and, like using a credit card to pay off a mortgage, that does not make it an attractive proposition to potential lenders.

What is the wider implication of a 7pc yield?

In November last year, Italy's borrowing costs surged past 7pc, eventually costing Silvio Berlusconi his job as Prime Minister and ushering in Mario Monti's austerity government, which has helped to calm the country's lenders.

Even worse, when the yields on Greek, Irish and Portuguese government debt got close to 7pc, those governments had to seek bail-outs from the European Union and International Monetary Fund because borrowing in the market was no longer an option.

That is why the 7pc level has taken on such significance in investors' minds.

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