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Credit crunch?

Out of 17 auctions for German government bonds so far this year, seven tenders undersold after failing to attract enough bids. The latest shortfall came Wednesday, when the government could sell only €3.208 billion ($5.06 billion) of a €4 billion new bond due in 2040. It carried an average yield of 4.91%, up from 4.45% in January.

Germany Pays More in Debt Issue

The German government had to sweeten the yield on its latest debt offering Wednesday, showing that even those European governments with relatively healthy budgets are struggling to overcome tight bank liquidity and market scepticism about economic and fiscal risks.

Out of 17 auctions for German government bonds so far this year, seven tenders undersold after failing to attract enough bids. The latest shortfall came Wednesday, when the government could sell only €3.2bn ($5.1bn) of a €4bn new bond due in 2040. It carried an average yield of 4.91%, up from 4.45% in January.

Countries such as France and Italy have to pay even higher interest rates than those on the benchmark German bonds to attract investors. Spain, which suffered its first budget deficit in three years for the first half of 2008, this month had to pull an issue of 15-year bonds because of tight market conditions.

The credit crisis hasn’t stopped governments from raising the money to fill budget gaps. But the cost of selling bonds has risen, particularly for countries such as Italy and Spain, where markets deem fiscal risks to be higher. Their difficulties could increase as economies continue to shrink, widening budget deficits and increasing perceived risk.

Investment banks - the usual customers for government debt - have become pickier about debt from countries like Spain, Italy and Ireland, where sharp economic slowdowns appear to present the most direct threat to budgets.

The Italian government now has to pay a yield on 10-year government debt that is half a percentage point higher than on comparable German government bonds, called bunds. That is double the spread of 0.2 to 0.25 of a percentage point that prevailed before the onset of the global credit crisis last August.

In market terms, it means that the Italian government has to pay 5.134% interest on its 10-year debt while the German government pays only 4.633% on a comparable issue. Similarly, the spread between Spanish and German 10-year bonds is about 0.3 percentage point. A year ago, the yields were almost even.

Germany’s economy has so far avoided the rapid slowdowns seen in the UK. and Spain, although recently it has seemed more likely to succumb to the strong euro’s impact on Germany’s exports. Chancellor Angela Merkel said Wednesday she saw slowing growth ahead, but still no signs of a recession. She stuck to current government forecasts, which call for 1.7% growth in 2008 and 1.2% growth in 2009.

“I think we might be able to see a very good year,” she said, referring to growth in 2008. “All prognoses for 2009 are significantly lower,” she added.

But now, even Germany apparently has to worry about the global liquidity crunch that has drained the funding institutional investors need to buy up debt.

“In general, it is a bit more difficult compared to before to sell their debt in auctions,” said Laurent Fransolet, head of European interest-rate strategy with Barclays Capital.

While markets are building in risk premiums, few currently believe any European governments will be in serious want of funding. Nor are any governments saying they expect to end 2008 with excessive funding gaps.

Stefan Olbermann, a spokesman for Germany’s Finance Ministry, said the German government isn’t putting too much thought into the matter. “At the end of the day, this is a problem for the markets,” he said, arguing that yield levels are determined by demand.

“There is reduced demand for paper in general,” said Simon Penn, an analyst with UBS. “From the corporate perspective, there has definitely got to be some sort of yield enhancement. What savings there are, are going to higher-quality paper.”

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Posted by jck at 8:11 am EST on July 24th, 2008 |