EZA 523 - Euro-Economy

24 April 2003

Upward Pressure for Bond Yields as Excessive Deficits Highlight Fiscal Pressures in Euro Area
Global credit spreads have narrowed for both sovereign and corporate issuers, indicating that global risk aversion has declined after the war in Iraq. Nevertheless, economic fundamentals on both sides of the Atlantic remain gloomy, indicating that economic weakness may persist. We argue that bond yields in the euro area are unlikely to slip back significantly, despite falling inflation and continued weakness in economic fundamentals, due to fiscal pressures in the big three euro area economies. Both Germany and France have been placed under the Excessive Deficit Procedure (EDP) and Italy has been criticized for its reliance on one-off rather than structural measures to avoid breaching the limit. Under the EDP, the excessive deficit must be corrected the year after it is reported, otherwise the country would be fined. We believe that neither Germany nor France is likely to correct their excessive deficits this year — and possibly next — with consequent repercussions on bond issuance.

SummaryAsset Conclusions: Fiscal pressures in the euro area will persist, particularly in France and Germany, putting upward pressure on bond yields.

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© Graham Bishop