Government bond sales in euro zone to fall on recovery

Signs of an economic upturn and improvement in budget outlook to help limit borrowing

PUBLISHED : Wednesday, 23 October, 2013, 3:54am
UPDATED : Wednesday, 23 October, 2013, 3:54am

Government bond sales in the euro area are set to fall next year to the lowest since the sovereign-debt crisis that threatened to splinter the common currency began, according to Morgan Stanley.

The decline, led primarily by Germany, vindicates European Central Bank President Mario Draghi, who said this month critics were wrong to predict a demise of the shared currency.

Bond sales by Italy and Spain are poised to stabilise, according to forecasts including those from JPMorgan Chase, Barclays and Credit Agricole Corporate & Investment Bank.

Signs of economic recovery and improvement in the budget outlook will help to contain future borrowing, the banks said. "Despite some slippage in the austerity program, we expect the fiscal deficit to shrink next year as the economy starts to grow," said Anthony O'Brien, co-head of interest-rate strategy at Morgan Stanley in London.

"We expect a virtuous circle to continue. As the systemic stress reduces, financing costs will drop further, funding positions will look better and the credit risk of peripheral nations will decline."

Morgan Stanley forecasts that euro-region nations will sell €827 billion (HK$8.8 trillion) of bonds next year, or €49 billion less than this year. Net of redemptions, the issuance will drop to €215 billion , the lowest since 2009.

Four years after the region's debt crisis erupted in Greece and nearly shattered the euro, most indebted nations' economies are on the mend as they benefit from the support of governments and the ECB, which broke the circuit between banking failures and sovereign purses.

Since taking over as head of the Frankfurt-based central bank in November 2011, Draghi has cut the main refinancing rate to a record low 0.5 per cent, flooded the banking system with more than €1 trillion of three-year loans and pledged in July 2012 to do "whatever it takes" to safeguard the single currency. Under an as-yet-unused Outright Monetary Policy program, announced in September 2012, the ECB said it would buy unlimited amounts of government bonds maturing in one to three years from nations that met certain criteria related to their debt.

European finance chiefs who met in Luxembourg last week said Ireland and Spain will soon be weaned off financial assistance, while Greece's mounting debt will be paid.

Bonds from Greece, Spain, Ireland, Portugal and Italy all advanced in the past month, extending their average returns this year to 14.3 per cent through October 18.

That compares with a loss of 1.8 per cent for German bonds and a 2.1 per cent decline in Treasuries.

The euro-area economy returned to growth in the second quarter after a record-long recession, helping to improve the budgetary outlook.

Gross domestic product rose 0.3 per cent from the previous three months, in line with an August 14 estimate, according to data published by the European Union's statistics office last month. From a year earlier, the economy shrank a revised 0.5 per cent. The ECB forecasts a 0.6 per cent contraction this year before the region returns to growth in 2014.

"The underlying story is that the macro data continues to be positive," said Gianluca Salford of JPMorgan in London.

"We don't see material risk on the horizon. There may be issues here and there that some investors are concerned about for various reasons, but it's not significant enough to give us a perception that things are really problematic."

The probability of a euro-area recession in the next 12 months has dropped to 20 percent from 65 percent in May, according to a median forecast of 14 economists in a Bloomberg survey.