Public debt in Europe is at record highs, and the interest that governments have to pay to finance themselves has in some cases reached levels that have not been seen for years. All the signs are that interest rates will eventually rise in the near future, thus credit for households and businesses will become more expensive.

The interest rate on German ten-year bonds rose to over 1% this week and Spanish bonds to 2%. Neither had been the case since 2015. The yield on the Spanish ten-year bond closed 2021 at 0.595%, after having reached negative levels in December 2020. As for the German bond, the increase has been considerable in the last two months, as it was negative at the beginning of March. On the other side of the Atlantic, the interest paid by the United States on ten-year bonds also exceeded 3% this week, something that has not happened since the end of 2018.

Interest rates on the debt of other European countries such as France, Portugal, Italy and Greece have experienced a similar trend to Germany’s in March and April, with increases in most cases of around one percentage point. Thus, the interest rate on French ten-year bonds is already close to 1.5%; Portuguese bonds are around 2%; Italian bonds have reached 2.8%, and Greek bonds are above 3%.

It should be noted that the European Central Bank (ECB), the Eurozone’s largest customer of government bonds, announced in March that its debt purchases would be drastically reduced this year. Its forecast is to go from the 80,000 euros per month it bought until recently to 20,000 million from June onwards.

New investors are being sought

This sharp decline in debt purchases means that supply and demand have to be readjusted, and the way to attract new investors is to increase yields. As a result, governments will have to pay more for their debt and their ability to invest will be reduced, which has an obvious negative effect on the economy.

Moreover, higher interest rates on public debt will make it more attractive to investors, with the result that some of the money that was previously used to finance the productive economy will now be used to buy public debt.

The end of an era

The reality is that the era of negative interest rates for European debt thanks to the ECB’s ultra-loose monetary policy is over. And the most fragile European economies in particular are suffering as a result of the risk of recession. They are seeing their risk premium, which is the extra cost they pay with respect to the ten-year German bond, increase. 

The risk premium attached to Spanish bonds, for example, remains slightly above 100 basis points, with peaks at the end of the daily sessions that have not been reached in the last two years. Like Italian and Portuguese yields, Spanish yields have risen by around 40% since January. And Greece’s is already above 230 basis points, having risen by more than 65% since the beginning of the year.

Each basis point of the risk premium is equivalent to 0.01% more interest than the yield on the German ten-year bond. Thus, 100 basis points means paying 1% more interest than Germany and 200 points is equivalent to 2% more.

The rise in interest rates is also affecting short-term debt. In the case of Spain, only bonds with maturity of less than one year are trading with negative interest rates, since in the last few days twelve-month bills have once again registered positive interest rates. And the trend is similar in other Eurozone countries.

Debt out of control 

This increase in the cost of financing will particularly affect the Eurozone’s most indebted economies. It should be borne in mind that the public debt of many countries has risen sharply in recent years. For example, in the case of Spain, its debt in February reached an all-time high of 1.442 trillion euros, according to the Bank of Spain. This represents 119% of GDP, whereas in 2008, before the onset of the economic crisis, the percentage was less than 40%.

In addition to this increase in debt and the interest rates that countries pay on it, there has been a change in the monetary policy of the major international players, who have raised or are considering raising the price of money to combat inflation. One example is the United States, which has just raised its interest rate by 50 basis points, and all forecasts suggest that the ECB will also end up raising rates in the near future to curb inflation. In short, everything points to a tightening of credit for SMEs, the self-employed and households.

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