After the escalation in the risk premium paid by Greece, Italy, Spain and Portugal for their debt, the intervention of the European Central Bank has restored some stability to the market. But the interest paid by these countries on their debt continues to rise, and the situation is becoming increasingly unsustainable.

On 14 June, Greece’s risk premium was dangerously close to 300 basis points, Italy’s was close to 250, Spain’s reached 140 and Portugal’s closed the session at 138. The interest rates payable by the countries of southern Europe on their debt had soared in recent days compared to Germany’s.

Because that is what the risk premium measures: each basis point of the risk premium is equivalent to 0.01 % more interest than the yield on the German ten-year bond. Therefore, 100 basis points means paying 1 % more interest than Germany and 200 points is equivalent to 2 % more.

In the first half of June, the market has been showing growing distrust in the debt payment of the PIGS, a pejorative acronym for Portugal, Italy, Greece and Spain by their initials. So the interest differential that these countries were forced to pay to place their debt bonds versus Germany had been rising.

Much ado about nothing

The European Central Bank (ECB) decided to take matters into its own hands and, after an emergency meeting, announced on 15 June that it would reinvest part of the portfolio of the Pandemic Emergency Purchase Programme (PEPP) to prevent the risk premiums of these countries from soaring. Everyone has inevitably interpreted this as a new bailout for these countries, as happened during the last crisis. Spain looks set to be rescued from bankruptcy once again by the ECB.

Since then, the situation has calmed down. The risk premium on Greek debt has fallen by 70 basis points in one week, Italian risk premium is now back below 200 points and Spanish and Portuguese risk premium is below 110 points.

In reality, the ECB’s announcement is nothing very new. As we explained in the article “ECB’s check on the most fragile economies”, in recent years the banking regulator has bought nearly two trillion euros in debt and announced in March that purchases would be drastically reduced as of June. But it also warned that it would reinvest the returned principal of securities purchased under debt purchase programmes “for as long as necessary to maintain favourable liquidity conditions”. Now it only goes a little further by adding the possibility of reinvesting the returned interest as well.

Good news?

The fact that the risk premium of the PIGS has fallen in recent days is good news in the sense that their financing has not soared relative to that of Germany. But this does not mean that the interest on their debt costs the same as before, because the interest paid by Germany on its ten-year bonds has risen by 1.78 percentage points in just four months.

German bond yields, which were at negative levels at the beginning of March, have risen steadily since then, even after the ECB’s emergency meeting, and now stand at 1.69 %. In short, both Germany and the PIGS are paying considerably more for their debt today than at the beginning of March.

More clouds than clear skies on the horizon

Complicated times lie ahead for everyone, although the PIGS’ cushion is obviously much thinner than that of countries such as Germany. The ECB’s future rate hikes in an attempt to control inflation should result in a generalised rise in the cost of debt. And, moreover, when the effects of the banking regulator’s recent announcement on debt purchases wear off, it cannot be ruled out that the spread between the southern European countries and Germany will increase again.

The ECB is running out of tools to maintain the stability of an economy that is caught between stagnation and inflation. And, with debt running out of control, the PIGS would be the main victims of any possible adjustment measures or cuts that Europe might demand in the future. 

Some warn that, if recession hits, the solidarity of Europe’s partners could crack, as it almost did a decade ago. From then on, the future of the Eurozone is unpredictable, as is the future of pensions and public health care.

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