Germany is having a good crisis. Its borrowing costs are plumbing record lows on haven demand for Bunds and its economy is growing strongly, with exports surging, helped by a weak euro.
But for many peripheral European economies, it is a very different story. Spreads – additional borrowing premiums over benchmark Bunds – hit fresh records in Ireland on Tuesday. In Portugal and Spain, spreads remain close to all-time highs.
Irish 10-year yield spreads against Germany rose to an all-time wide of 357 basis points, compared with 145bp at the start of the year. Spain’s 10-year bonds trade at 192bp above Germany, compared with 57bp at the start of the year while Portugal is trading at 333bp, compared with 67bp on January 1.
Greece has even wider spreads but does not face these problems, at least not at the moment, given that Athens does not have to rely on finance from private markets for the next two years, .
But this growing divergence in borrowing costs is prompting worries that it will become harder for the weaker countries of the 16-member eurozone – most notably Ireland, Portugal and Spain – to compete with resurgent economies such as Germany.
Ireland’s economy is experiencing extremely weak growth and even flirting with deflation.
The economies of Spain and Portugal are in a similar position with their economies registering very weak growth.
Higher government borrowing costs hurt economies in several ways, from raising lending costs for companies and putting more strain on the country’s public finances.
John Wraith, fixed income strategist at BofA Merrill Lynch Global Research, says: “The eurozone is not a level playing field as Germany has a big competitive advantage.
“Economies such as Ireland and Spain have to pay much more to borrow the same amount as Germany.
“It is much harder for these economies to compete with such an efficient competitor in Germany in terms of exports. They can sell at a cheaper rate as they can have lower borrowing costs.
“This, in turn, means while German exports and growth benefit, those of other economies do not.” Weaker eurozone economies are also hindered by the eurozone exchange rate, being kept stronger by German economic strength. Unlike the UK, eurozone economies cannot fall back on a weaker currency to boost their competitiveness in the export market.
However, some analysts point out that Europe’s peripheral economies benefit from strong haven demand for German Bunds which pushed German 10-year yields to record lows at 2.09 per cent on Tuesday. These same analysts stress that absolute yields are not that high for countries such as Ireland, Portugal and Spain.
Spanish 10-year yields are trading at 4.02 per cent, much lower than they were before the financial crisis, despite a widening in spreads. In July 2007, they were close to 5 per cent.
Even Ireland, which has seen a big sell-off in its bonds in recent weeks because of worries over its banking system, has 10-year yields that are half those seen in the 1990s.
David Lloyd, head of institutional portfolio management at M&G Investments, says: “There are very wide spreads between Germany and some of the eurozone markets, but overall yields are not that high.
“The overall borrowing costs of, say, Spain are, for now, not that punitive. And in many respects, how much it costs a country to service its debt is what matters.”
Mr Lloyd also points to the steepness of the yield curve, or the difference in the very low yields of short-dated bonds and the much higher yields of 10-year or 30-year bonds as a sign that economies will normalise.
The 150bp difference between two-year and 10-year German bonds suggests that the uncertainty that is keeping rates low is not likely to last into the medium term.
However, most analysts agree eurozone imbalances will weigh on growth for weaker economies.
Alan Wilde, head of fixed income and currency at Baring Asset Management, says: “Wide spreads between Germany and the weaker eurozone economies do matter and make it difficult for the weaker economies.
“If German bonds continue to outperform, this highlights the lack of competitiveness and necessary adjustment required by the weaker eurozone members.
“It is also self-perpetuating as the higher relative borrowing costs exacerbate competitiveness issues, putting further pressure on the bond markets of the weaker economies.”