BRUSSELS, May 9 (Reuters Breakingviews) - The European Union’s debt credibility is suffering from rising doubts, as well as rising rates. While yields are up across the 27-nation bloc, its jointly issued bonds now trade above those of France instead of roughly parallel. To close the spread the EU needs a shift in investor mindsets, and to make good on some revenue-raising promises.
Relative to initial projections, EU borrowing costs are on course to go up by tens of billions of euros. The EU’s cost of funding has grown from 0.14% in 2021 to 2.6% in the second half of 2022, with further rises expected. With outstanding bonds of 381 billion euros as of end-April and more coming, the extra costs add up.
Part of that is the unavoidable consequence of rising rates in general. Even so, as of Tuesday, two-year EU bonds were yielding 3.02% compared to 2.79% for France and 2.94% for Spain, with five-year EU bonds at 2.87% against 2.63% for France. Even though the EU is rated AAA by Fitch and Moody’s as well as AA-plus by S&P, higher than France’s Aa2 at Moody’s, AA-minus at Fitch and AA at S&P, the bloc is paying more in part because markets have not accepted Brussels as a sovereign borrower.
EU debt trades as a supranational institution, not a country. Hence it is left out of government bond indexes and portfolio slots. If it was included, asset managers would be more likely to sell France and buy the EU, earning extra yield on similarly rated sovereign debt. Right now, they mostly aren’t.
This puts the European Commission in a bind. Its technical campaign to jump categories has not taken hold, despite the support of the European Central Bank, which last year promoted EU debt to its top tier of monetary policy collateral. Market participants like LBBW Chief Economist Moritz Kraemer say the euro area has not proven its political will to stick together. Critics focus on the pandemic borrowing programme’s temporary nature as well as the common currency’s near-breakup during its 2010-2015 crisis.
This leads to a situation where even though there is plenty of well-managed debt to trade, market participants are already pricing in a future lack of liquidity. Other reserve currency safe assets, like U.S. Treasury bonds or Japanese debt, face no such prospective cuts in supply. On top of that, the EU has boxed itself in with promises to pay its obligations down with new sources of revenue that have not yet materialised, such as digital and carbon taxes.
This looks bad. Financially, the EU general budget will be able to manage the increase in debt costs using existing measures. But for political leaders to get more comfortable with joint debt and to advance the euro as a reserve currency, Brussels needs to convince member states to deliver on promised new revenues. If they don’t, pan-European bonds could wind up like the unfinished EU banking union: another reminder that euro countries aren’t totally sold on being joined together.
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CONTEXT NEWS
The European Union’s costs of borrowing have risen substantially, from 0.14% in 2021 to 2.6% in the second half of 2022. Through last year, the EU earned enough interest on funds it was holding to create a positive carry that offset the rise in borrowing rates. But in 2023 that is expected to swing the other way, creating a new layer of administrative costs.
The EU became a major bond market player in 2020, when it pledged to borrow about 900 billion euros on public markets to support its NextGenerationEU recovery programme and a related unemployment-fighting initiative.
Net new borrowing for the pandemic programmes is due to end in 2026, but the EU will continue to maintain a large market presence in managing its existing portfolio. It will also continue to borrow to support aid to Ukraine and other goals.
