The Lemon Fool

The EU financial structure comprises, a Single Currency (Euro), ECB interest rate which is common for all EU member states, maybe soon to be 0.5%.

What I don't understand is why each member state has its own 2 year, 10 year bond yields. The current spread between German and Italian yields is widening as Italy faces political turmoil.

Why do member States have individual bond yields and doesn't this defeat the integrated EU financial model.

Hope this is a sensible question. Thanks .

scotview wrote:The EU financial structure comprises, a Single Currency (Euro), ECB interest rate which is common for all EU member states, maybe soon to be 0.5%.

What I don't understand is why each member state has its own 2 year, 10 year bond yields. The current spread between German and Italian yields is widening as Italy faces political turmoil.

Why do member States have individual bond yields and doesn't this defeat the integrated EU financial model.

Hope this is a sensible question. Thanks .

Because, in theory at least, members are not responsible for each others borrowings and the market reckons the risk of the default is not zero and is higher for Italy, for example, than Germany. The financially incontinent countries would of course love debt liability to be shared at EU level, whilst the more prudent countries do not want that to happen.

Similar to US municipal (state) bond yields, and Federal/Treasury (total US/collective) rate. Same currency, different spending/economics between states. If one member state irresponsibly borrows/spends then its default risk rises and investors demand a higher yield for lending.

If the rates were the same for all countries, who would lend to Italy and Greece (and who would not lend to Germany)?

scotview wrote:The EU financial structure comprises, a Single Currency (Euro), ECB interest rate which is common for all EU member states, maybe soon to be 0.5%.

What I don't understand is why each member state has its own 2 year, 10 year bond yields. The current spread between German and Italian yields is widening as Italy faces political turmoil.

Why do member States have individual bond yields and doesn't this defeat the integrated EU financial model.

Hope this is a sensible question. Thanks .

Definitely a sensible question. To add to scrumpyjack's sensible answer, do note that ECB interest rates and EU member state bond yields are not the same thing. For starters, there is one ECB interest rate but a different yield for each tranche of an individual country's bonds, depending on the maturity of the bond. The ECB interest rate is set by a committee at the ECB while the bond yields are calculated from the prices at which the bonds trade in the market. Short-dated bonds tend to have lower yields while longer dated bonds tend to have higher yields -- all from the same issuer. Bond investors refer to a yield curve, which is a plot of these bond yields versus the corresponding maturity. Here is an example for bunds:

http://www.worldgovernmentbonds.com/country/germany/

Each country's bonds has its own yield curve because it is responsible for repayment of its own bonds and as scrumpyjack said, the risk of failure to repay varies from country to country, even though they share a currency.


GS

They shouldn't do and one of the reasons for some countries joining the single currency was they wouldn't. Before the Greek bailout Greece could borrow at rates not far different from Germany. A pretty big deal.

Yield reflects risk of default and for a long time the illusion was that a default in a Eurozone country was impossible. It's been a while but I'm pretty sure Greece didn't actually default, so the illusion maybe true. However the reality was forced haircuts were inflicted, so the the net impact was the same, lenders lost capital. Moreover, the Eurozone upended the way debt normally works. The same bond behaved differently depending upon the owner. It also impacted only debt written under Eurozone jurisdiction. This limitation was one reason the EU wanted to bring London under it's control. It could then have unilaterally changed the bond terms for a lot more debt. In the end those foreign law bonds paid their coupons in full redeemed at par, some astute vultures made huge sums of money.

Lesson - If one must buy Euro country debt buy the stuff written under UK/US jurisdiction and keep your nerve.

After Greece the bubble was burst, investors realised that all Eurozone countries were not Germany and bonds not being repaid was a realised risk so the pricing adjusted. Not that they adjusted enough IMHO, Italian bond holders are going to get haircut one day, just no one really knows when.

There has been a development since those days, the ECB is now issuing pooled bonds, under Covid recovery cover, one day this will be the way debt works in the EU, Eurozone countries will no longer issue their own debt, it will be done via the EU centrally, then there will be one rate. The flip being they will all also no longer create their own budgets, they will instead be told what they may spend and tax, just like Greece is. In essence the EU intends to become like the UK.

When they talk European "Union", they really mean it.

ayshfm1 wrote:Eurozone countries will no longer issue their own debt, it will be done via the EU centrally, then there will be one rate. The flip being they will all also no longer create their own budgets, they will instead be told what they may spend and tax, just like Greece is. In essence the EU intends to become like the UK.

When they talk European "Union", they really mean it.

And Scotland wants to leave the UK union, and look to join the European Union, with considerably less of a voice? Swap out 59 UK MP's for less than a handful of MEP's. Along with many years in isolation before a newly independent Scotland could demonstrate its suitability for EU membership.