Spain debt

Prospects for rate hikes worry debt-ridden eurozone countries

Investors are starting to worry again about high levels of government debt in the euro zone, with the prospect of higher interest rates reigniting concerns that had largely lain dormant in recent years.

Borrowing by indebted countries, including Italy, Greece and Spain, has increased in the decade since the region’s sovereign debt crisis, in part due to the drain of the coronavirus pandemic on public finances.

Markets were more willing to fund these large debt piles as borrowing costs were rock bottom and the European Central Bank continued its massive bond-buying program. But the ECB’s plans to withdraw those stimuli – with the end of asset purchases and a quarter-point rate hike scheduled for July – mean that bonds from these southern European countries are once again under pressure.

Borrowing costs for Italy and Greece have risen sharply, with Italy’s 10-year yield hitting its highest level since 2014 on Friday – although they remain well below the highs reached in 2012. Still, many investors fear that a sustained rise could reignite. concerns about Rome’s or Athens’ ability to manage debt.

“I think the situation is worrying but not critical,” said Antoine Bouvet, senior rate strategist at ING. “Sometimes markets can go into a frenzy and lose confidence,” he said, adding that it becomes a “self-fulfilling prophecy.”

He said if the spread between Italian and German benchmark yields reaches 2.5%, then “some alarm bells will start ringing at the ECB.” The spread narrowed to around 2.25% on Friday.

“So far [the widening] was relatively orderly, but it could lull the ECB into a false sense of security,” Bouvet added.

In a policy statement this week, the ECB said it planned to raise interest rates by 0.25 percentage points in July and that “if the medium-term outlook for inflation persists or deteriorates, a larger increase will be appropriate at the September meeting.”

The bank last raised rates in 2011 and its deposit rate currently sits at minus 0.5%.

On fears of fragmentation – the idea that tighter monetary conditions could have a different impact on eurozone countries – ECB President Christine Lagarde said on Thursday that if necessary, “we will deploy either existing adjusted instruments or new instruments that will be made available”.

“Obviously we need to make sure that there is no fragmentation that would prevent the proper transmission of monetary policy,” she added.

Additional reporting by Tommy Stubbington