The economic crisis, inflation and the withdrawal of monetary stimuli multiplies the interest rate of the ten-year Spanish bond by five
Returns the risk premium. It is the difference between the interest rate of the ten-year German bond and that of Spain or any other country in the euro zone. The ECB’s announcements about the progressive end of the purchase of debt in the countries of the euro zone have been mixed with fears of a sharp slowdown in the economy -if not, a recession- and the result is turbulence in the markets that is punishing the most vulnerable countries due to their high level of deficit and debt and low growth potential: Greece, Italy, Spain and Portugalhim, in this order. This Wednesday, the simple announcement of an extraordinary meeting of the ECB to avoid a new financial fragmentation in the euro zone has served so that in a few hours the Spanish risk premium has dropped from 137 points (on Tuesday) to 127 points and to bring the gains to stock indices.
How is the risk premium evolving in Spain?
The difference between the German 10-year bond and the Spanish one was barely 68.55 basis points at the beginning of 2022. Then the interest rate on the German 10-year bond was negative, -0.05% in the market secondary. In the case of the Spanish bond, the interest rate was also very low (although not that low): 0.64%. This Tuesday the risk premium had doubled, up to 137.60 points. Galloping inflation and the economic crisis caused by the war in Ukraine have pushed the interest rate on the German bond up to 1.76%. In the Spanish case, the interest rate on the bond has risen to 3.14% (a distance of 137.60 basis points between the two) and has multiplied by five since the beginning of the year.
Why are public debt interest rates rising?
Since 2012, when the then president of the ECB, Mario Draghi pronounced his famous ‘Whatever it takes’ (whatever it takes), the European Central Bank has not stopped buying public debt from member states. First, to get around the debt crisis at the time. Later, to accompany the recovery of the economies. With the outbreak of the pandemic -when the risk premiums of the most vulnerable countries soared (the Spanish one reached 141 points)- an extraordinary debt purchase program was launched that has already been cancelled. This monetary policy action made it possible to put an end to the so-called “financial fragmentation”, which is nothing more than the enormous difference in interest rates on debt between the safest countries (Germany) and the most vulnerable. In July 2012, the Spanish risk premium reached 650 basis points, with the return on the Spanish bond above 7.7%. The ECB’s monetary policy put an end to that nightmare thanks to the purchase of public debt. The fear of the effects of the end of purchases, in a context of crisis and uncertainty, has returned fear to economies such as Greece, Italy, Spain and Portugal.
Why does the risk premium punish Italy, Greece, Spain and Portugal more?
These four countries suffer from high levels of deficit –which must be financed each year by issuing public debt- and public debt (which must be permanently refinanced in the financial markets, as the titles mature). These economies depend on the money that financial markets can lend them. When there is uncertainty and crisis and when there is a very large number of countries that, for this reason, seek investors to lend them money, they choose the economies that they consider safer (Germany or the United States); they only lend to others in exchange for a higher interest rate. What has happened these years is that the ECB has been buying debt in the secondary market of the countries. There was not as much money to borrow from investors and they could not demand too high rates. Now that the ECB plans to stop buying, investors have started asking for higher interest rates in return. The risk premium has reached 294 this Tuesday in Greece; 250 points in Italy; 137.60 points in Spain and 137.30 points in Portugal. In another division they play, for example, Holland, where the risk premium has reached only 37.20 points; France, with a maximum this year of 63.10 points and even the once rescued Ireland, where the risk premium reached a peak of 73.75 points on Tuesday (almost half that of Spain)
What can the ECB do?
Despite the ongoing process of normalizing the ECB’s monetary policy, its president, Christine Lagarde, has been pointing out for months that the institution will mediate to avoid the risk of financial fragmentation between the countries of the euro zone. This Wednesday, the simple announcement of an extraordinary meeting of the ECB to avoid a new financial fragmentation in the euro zone has served so that in a few hours the Spanish risk premium has dropped from 137 points (on Tuesday) to 127 points.
Why is the rise in the risk premium serious?
The increase in public debt means that countries must allocate a greater part of their budget to pay interest rates, detracting from other public policies (investment or social spending). Despite the fact that the Spanish level of public debt soared by 24.5 points and reached 120% of GDP in 2020 (to deal with the effects of the pandemic), spending on interest payments has remained stable, thanks to the monetary policy of the ECB. The fear now is that the increase in interest rates translates into greater public spending in this area.