Rising Yield Will Test EU 800 Billion Promise

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It’s reassuring that the EU still enjoys strong investor demand for the debt it sold to finance its 800 billion euros ($840 billion) NextGeneration pandemic recovery fund. Less welcome is the nearly tenfold increase in its funding costs compared to what was paid at the height of the pandemic. Soaring inflation would make shoring up the bloc’s economy much more expensive, distributing the pain of higher yields across the region.

The European Union raised 5 billion euros this week, selling bonds payable by 2048 with investors bidding for seven times the amount offered. The relatively attractive interest rate of 2.625%, and the yield about 80 basis points higher than the German rate and in line with French debt, helped boost demand.

For borrowers, however, that compares to the 10 billion euro 2050 deal issued in November 2020, which came with just a 0.3% coupon and yield spread over the German equivalent at the time of around 25 basis points. The security is now trading at 53% of face value, illustrating how quickly the capital value of ultra-long-maturity, low-coupon debt can erode in an increasing yield environment. Credit spreads, even for supranationals such as the EU, have widened markedly compared to Germany; bond markets are not waiting for the European Central Bank to actually raise the official deposit rate to negative 0.5% before changing prices for the changing monetary environment.

After raising nearly 100 billion euros for its economic support package, the EU’s remaining loan needs at the end of 2026 put its forthcoming issuance in the same ballpark as Germany, France, Italy and Spain. The original plan was to borrow 50 billion euros in the first half of 2022; even after Tuesday’s deal, it’s still only about half that pace, so it will take more issuance later this year to keep up with the 150 billion euros annual capital increase target reaffirmed in the May update—and at higher yields in effect. .

The brutal reality is beginning to emerge that financing a pandemic recovery is likely to be far more expensive than previously thought. Even as recently as late last year, much of Europe’s debt was essentially free money. The EU’s average interest rate is still below 1%, with more than a third of the 295 billion euros of outstanding bonds to be paid in more than 10 years. Having to pay a coupon of 2% and more for medium to long-maturity debt will change the overall cost dynamics substantially.

The rising costs of supporting countries such as Italy and Greece, with their already excessive debt relative to gross domestic product, will be felt across the continent with the political tensions that come with it. We’ve seen this film before, so some thought has to be put into the viability of the EU’s support mechanism if it doesn’t stumble upon its first bond market hurdle. The creation of the package is a testament to Europe’s solidarity in its collective response to the pandemic; Similar cohesion will be needed in the months and years to come.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was chief market strategist for Haitong Securities in London.

More stories like this are available at bloomberg.com/opinion

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