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10 Jun 2014
Periphery Eurozone debt costs fall, but weak fundamentals remain unchanged
FXStreet (London) - European periphery sovereign bond yields have continued to fall following the European Central Bank’s (ECB) drastic announcements last week. But the sustainability of the effects of the central bank policy announcements is uncertain.
Spanish borrowing costs have fallen below those of the US, with Spanish 10-year bonds currently yielding 2.57 percent compared to US Treasury yields of 2.61 percent. At the same time, Irish yields have declined to 2.62 percent and Italian yields have dropped to 2.71 percent.
But while the decline in peripheral bond yields will come as welcome news to many, not least those banks with outsized sovereign debt exposures, the rally should not be confused with a pickup in the fundamentals of the Eurozone periphery or core states.
While French industrial output rebounded 0.3 percent in April, according to data released this morning by Insee, the numbers failed to meet expectations, and comes after an upward-revised 0.4 percent decline in April. German industrial production gained just 0.2 percent month-on-month in April and the Eurozone GDP gained 0.9 percent year-on-year ending the first quarter.
ECB measures
Last week, the ECB announced a cut of its entre rate corridor. The main refinancing rate was cut 10 basis pointsto 0.15 percent, from 0.25 percent. More significantly, the Bank cut the deposit rate into negative territory for the first time – to -0.1 percent from 0 percent. The marginal lending facility rate was cut by 35 basis points from 0.75 percent to 0.4 percent.
In addition, the ECB will suspend its sterilisation of its securities market programme (SMP), although it had already regularly failed to sterilise SMP purchases in recent months. The central bank will also carry out targeted long-term repayment operations in September and December. In the announcement, ECB president Mario Draghi said that: “the determination that this money not be spent on sovereigns and on sectors that are already experiencing or are just coming out of a bubbly-ish situation.”
ECB measures could be ineffective
With the Eurozone as a whole suffering from weak job creation, high unemployment and contracting private credit, it remains doubtful whether last week’s proposed measures will have any fundamental beneficial effects.
The Denmark experiment in particular does not bode well for the ECB’s introduction of negative deposit rates in an effort to spur lending. While Damenrk’s objectives were very different – targeting unwanted krona strength rather than fighting disinflationary pressures and supporting inflation expectations – it is likely that we will see a similar reaction from the banks. During the Danish flirtation with negative rates, banks largely swallowed the cost of negative rates rather than pass on costs to retail depositors. Should this happen within the Eurozone, the damage to profitability may be balanced by profits on Eurozone sovereign debt holdings.
In addition, it is doubtful whether the TLTRO will be a success. The cost of borrowing has been a record-low levels throughout the period that the Eurozone has seen a steady crumbling of private sector credit. It is not the price of credit that has been a barrier to private loans, but a lack of economic growth and business creation within the Eurozone that has reduced credit demand.
Spanish borrowing costs have fallen below those of the US, with Spanish 10-year bonds currently yielding 2.57 percent compared to US Treasury yields of 2.61 percent. At the same time, Irish yields have declined to 2.62 percent and Italian yields have dropped to 2.71 percent.
But while the decline in peripheral bond yields will come as welcome news to many, not least those banks with outsized sovereign debt exposures, the rally should not be confused with a pickup in the fundamentals of the Eurozone periphery or core states.
While French industrial output rebounded 0.3 percent in April, according to data released this morning by Insee, the numbers failed to meet expectations, and comes after an upward-revised 0.4 percent decline in April. German industrial production gained just 0.2 percent month-on-month in April and the Eurozone GDP gained 0.9 percent year-on-year ending the first quarter.
ECB measures
Last week, the ECB announced a cut of its entre rate corridor. The main refinancing rate was cut 10 basis pointsto 0.15 percent, from 0.25 percent. More significantly, the Bank cut the deposit rate into negative territory for the first time – to -0.1 percent from 0 percent. The marginal lending facility rate was cut by 35 basis points from 0.75 percent to 0.4 percent.
In addition, the ECB will suspend its sterilisation of its securities market programme (SMP), although it had already regularly failed to sterilise SMP purchases in recent months. The central bank will also carry out targeted long-term repayment operations in September and December. In the announcement, ECB president Mario Draghi said that: “the determination that this money not be spent on sovereigns and on sectors that are already experiencing or are just coming out of a bubbly-ish situation.”
ECB measures could be ineffective
With the Eurozone as a whole suffering from weak job creation, high unemployment and contracting private credit, it remains doubtful whether last week’s proposed measures will have any fundamental beneficial effects.
The Denmark experiment in particular does not bode well for the ECB’s introduction of negative deposit rates in an effort to spur lending. While Damenrk’s objectives were very different – targeting unwanted krona strength rather than fighting disinflationary pressures and supporting inflation expectations – it is likely that we will see a similar reaction from the banks. During the Danish flirtation with negative rates, banks largely swallowed the cost of negative rates rather than pass on costs to retail depositors. Should this happen within the Eurozone, the damage to profitability may be balanced by profits on Eurozone sovereign debt holdings.
In addition, it is doubtful whether the TLTRO will be a success. The cost of borrowing has been a record-low levels throughout the period that the Eurozone has seen a steady crumbling of private sector credit. It is not the price of credit that has been a barrier to private loans, but a lack of economic growth and business creation within the Eurozone that has reduced credit demand.