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Rising Yields Will Test EU’s 800 Billion-Euro Promise

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It’s reassuring that the European Union still enjoys strong investor demand for the debt it’s selling to finance the 800 billion-euro ($840 billion) NextGeneration pandemic recovery fund. Less welcome is the near tenfold increase in its funding costs compared with what it was paying at the height of the pandemic. Soaring inflation will make underpinning the bloc’s economy a lot more expensive, distributing the pain of higher yields across the region.

The EU raised 5 billion euros this week, selling bonds repayable in 2048 with investors bidding for seven times the amount offered. A relatively juicy 2.625% interest rate, and a yield about 80 basis points more than German levels and in line with French debt, helped boost demand.

For the borrower, however, that compares with a 10 billion-euro 2050 deal issued in November 2020, which came with just a 0.3% coupon and a yield spread over the equivalent German benchmark at the time of about 25 basis points. This security now trades at 53% of face value, illustrating how swiftly capital values of ultra-long maturity, low-coupon debt can erode in a rising yield environment. Credit spreads, even for a supranational like the EU, have widened noticeably versus Germany; the bond market isn’t waiting for the European Central Bank to actually raise its negative 0.5% official deposit rate before repricing for a changed monetary environment.

Having already raised nearly 100 billion euros for its economic support package, the EU’s remaining borrowing needs by the end of 2026 put its forthcoming issuance in the same ballpark as Germany, France, Italy and Spain. Its original plan was to borrow 50 billion euros in the first half of 2022; even after Tuesday’s deal it is still only at about half that pace, so it will require a lot more issuance later this year to keep on track with the annual capital-raising target of 150 billion euros that it reiterated in its May update— and at the prevailing higher yields. 

The brutal reality is dawning that financing the pandemic recovery is likely to be substantially more expensive than first envisaged. Even as recently as late last year, much European debt was essentially free money. The EU’s average interest rate is still below 1%, with more than a third of its 295 billion-euros of bonds outstanding repayable in more than 10 years. Having to pay coupons of 2% and more for medium- to long-maturity debt is going to change its overall cost dynamics substantially.

The rising cost of supporting nations such as Italy and Greece, with their already excessive debts relative to gross domestic product, is going to be felt across the continent with concomitant political strains. We’ve seen this movie before, so some thought is going to have to be put into the viability of the EU’s support mechanism if it is not to stumble at its first bond-market hurdle. The creation of the package was a testament to European solidarity in its collective response to the pandemic; similar cohesion will be required in the months and years ahead.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was chief markets strategist for Haitong Securities in London.

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