ROME (MNI) – A recent study for the Bank of Italy argues that the
spread between Italian and German government borrowing costs is not
justified by economic fundamentals and may be explained by a risk
premium associated with a potential break-up of the Eurozone.
The study released Tuesday by the Italian central bank, entitled
“Recent Estimates of Sovereign Risk Premia for Euro-Area Countries,”
supplies econometric backing for the arguments of peripheral governments
that they are paying the price of mounting doubts over the survival of
the euro.
According to the authors: “Both previous analyses and the new
evidence presented in the paper suggest that, in recent months, for
several countries the spread has increased to levels that are well above
those that could be justified on the basis of fiscal and macroeconomic
fundamentals.”
“For Italian government bonds, most estimates of the value of the
10-year spread consistent with fundamentals are around 200 basis points,
against its market value of about 450 points” at end-August, they
conclude.
The values estimated on the basis of fundamentals are also markedly
lower than the actual values for two-year spreads (180 bps versus 410
bps) and five-year spreads (270 bps vs 490 bps).
A significant part of these spreads is due in part to the sharp
fall in German Bund yields benefitting from safe-haven flows, the
authors acknowledged.
As the sharp rise in spreads over the past year cannot be explained
by fundamentals such as economic growth, fiscal conditions and financial
risks, the authors explore other explanations. Even assuming a
re-pricing of sovereign risks due to “a biased perception” of market
participants does not fully explain the large discrepancies, they say.
Instead, “the natural and most likely candidate for the large gap
between the market and model-based values of sovereign spreads is the
perceived risk of a break-up of the euro area,” they conclude.
“Concerns about the fragility of the euro are increasingly and
widely mentioned by a number of market observers and have apparently
caught the attention of the public at large,” they conclude. “The
assumption of a prominent role of euro break-up risks is also
corroborated by some new findings presented in this paper.”
“For the bonds issued by some ‘core’ and ‘non-core’ countries, the
deviations of the yields from the values justified by fundamentals are
in opposite directions,” the authors note. “Moreover, those deviations
turn out to be strongly correlated with an indicator of euro break-up
risks.”
“Fears of the reversibility of the euro can thus explain the
current high dispersion of interest rates within the euro area and be a
major source of uncertainty and systemic risk,” they warn.
– Paris newsroom +331 4271 5540: ssandelius@marketnews.com
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