Viewpoint: The rebound in risk premiums seen over recent weeks is rooted in fundamentals

The rebound in risk premiums seen over recent weeks is rooted in fundamentals, but also reflects the need for mechanisms geared to controlling refinancing risk….

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so as to allow governments the necessary time to complete their deficit reduction processes. There seem to be no alternatives to ECB aid for a few months to come.
The resurgence in risk premiums on the European debt markets is surely rooted in fundamentals, which have contributed to doubts over the actual implementation of the fiscal consolidation plans laid out by Italy and Spain. The issue lies more with Spain than with Italy: if in Italy the problem was mostly due to a borrowing requirement in the first quarter of the year excessively large if compared with a linear hypothetic path leading up to the year-end target, in Spain actual 2011 data fell well short of expectations, discrepancies emerged between the cash and accrual budgets, the 2012 target was revised upwards amidst tensions and turmoil, and just a week after its unveiling the Budget was also revised. Such confusion has overshadowed the significant progress made on the front of reform.
However, all the above should not distract from the fact that another, system-wide component lies behind the latest violent correction: the market’s scepticism on the sustainability of government bond demand, also in relation to the waning effects of the support measures put in place by the ECB. The effects of the first two 36-month LTROs tapered off in the first fortnight of March; the Securities Market Programme, predictably dormant in the “boom” phase, has always met with resistances within the ECB’s governing council, and should theoretically be replaced by an EFSF programme: it is no surprise that the markets have started to doubt that the SMP will even be used again. But without support from the ECB, and with foreign demand still presenting more speculative than structural connotations, can a balance between demand and supply be guaranteed on the government bond market? This leads us back to the problems encountered, albeit in a more dramatic form, at the end of 2011: in high-debt countries especially, deficit reduction does not significantly reduce refinancing risk. A winning strategy cannot be limited to restoring sound public finances, but also needs to address measures guaranteeing that borrowing requirements are met at reasonable costs for the time required to implement consolidation measures.
On this front, the euro area still has a lot to do. The only operational mechanism in place is the ECB’s SMP. Recourse to new long-term refinancing operations would risk proving ineffective, given the spasmodic focus on the exposure of banks to government bonds. In theory, today the EFSF could take over a programme of selective interventions on the secondary market, taking advantage of the ECB as its operational branch; however, the European fund’s lack of resources advise against carrying out interventions in this relatively inefficient mode. On the other hand, the activation of traditional or pre-emptive EFSF programmes, with the aim of supporting the primary market in countries under pressure, if ill-designed could compromise confidence in the states involved, rather than bolster it. Also, the resources available would risk being used up very rapidly. For these reasons, there do not seem to be many alternatives to further use of the SMP, if necessary. From this point of view, Coeure’s statements on the possibility of the instrument being resorted to again, are a positive development.


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