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Is the EU Recovery Fund at risk from the explosion of borrowing costs?

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Is the EU Recovery Fund at risk from the explosion of borrowing costs?

By Marcus Ashworth

It is reassuring that the European Union continues to enjoy strong investor demand for the debt it sells to finance the € 800 billion Pandemic Recovery Fund (NextGenerationEU).

It is less welcome to increase its funding costs by almost 10 times compared to what it paid at the height of the pandemic. Rising inflation will make it much more costly to support the bloc economy, sharing the pain of higher yields across the European region.

The EU raised € 5 billion this week by selling bonds maturing in 2048, with investors bidding for seven times what they offered. A relatively “juicy” interest rate of 2.625% and a yield of about 80 basis points higher than that of German bonds, ie close to that of the French debt, helped stimulate demand.

The scene has changed

For the collective European borrower, however, this compares to a € 10 billion deal for 2050 maturing bonds issued in November 2020, which came with a coupon of just 0.3% and a yield difference with the German benchmark of that period. about 25 base units.

The stock is now trading at 53% of its nominal value, demonstrating how quickly the capital values ​​of extremely long-term, low-interest debt can erode in an environment of rising yields.

Credit spreads, even for a supranational entity like the EU, have widened significantly compared to Germany. The bond market does not expect the European Central Bank to substantially raise the negative official deposit rate of 0.5% in order to proceed with a revaluation in a changing monetary policy environment.

The spread of EU debt returns relative to that of Germany has been steadily expanding over the last two years

Version slowdown

Already raising almost € 100 billion for the bailout package, the EU’s remaining borrowing needs by the end of 2026 put its forthcoming issues in the same field as those of Germany, France, Italy and Spain.

Its original plan was to borrow 50 billion euros in the first half of 2022. Even after Tuesday’s auction, it is still about half that rate, so it will need much more releases later in the year to continue the annual The € 150 billion capital raising target, which the Union reaffirmed in its May update – and even with the highest yields prevailing.

The brutal reality that is emerging is that funding for the pandemic recovery is likely to be significantly more expensive than originally anticipated.

Even just at the end of last year, much of Europe’s debt was virtually free money. The EU’s average debt repayment is still below 1%, with more than a third of the € 295 billion outstanding bonds repayable in more than 10 years.

The obligation to pay coupons of 2% or more for medium to long-term debt will significantly change the overall dynamics of these costs.

The entire EU debt performance curve has moved higher in 2022

Pressures

The rising cost of supporting countries such as Italy and Hellaswith their already excessive debts in relation to their Gross Domestic Product, will be felt throughout the continent, with consequent political pressures.

We have seen this work in the past, so some considerations need to be made about the viability of the EU support mechanism if the 27-nation bloc does not want to stumble on the first hurdle it encounters in the bond market.

The creation of the Recovery Fund was a testament to European solidarity in the field of collective response to the pandemic.

Similar cohesion samples will be required in the coming months and years.

Source: Bloomberg

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