Borrowing costs for so-called core members of the euro zone like France, Austria, Belgium and the Netherlands have been rising sharply in recent weeks as investors bet the problems facing peripheral members of the euro zone will not be contained.
Analysts at Capital Economics have been asking if the recent rise in core yields means the crisis is about to take a significant turn for the worse and believe the market is underestimating the vulnerability of France.
“Yields have started to rise rapidly – not because investors now expect tighter monetary policy, but because they are increasingly concerned that policymakers will not be able to contain the crisis and perhaps even keep the euro zone together at all” said John Higgins, the senior markets economist at Capital Economics in a research note.
With the spread between French and German borrowing costs rising to its highest level since the creation of the euro, Higgins believes the gap could rise further still “if Greece defaults and leaves EMU and recent troubles in Italy and Spain start to intensify.”
France’s Finance Minister Francois Baroin said late on Monday that the cost of French borrowing remained at “very favorable” levels following a warning from Moody’s that a further rise in borrowing costs could hurt France’s credit rating.
Capital Economics has long been of the view that the euro zone could break up.
Higgins says a break-up would not necessarily mean default for the likes of France but warns the market is not about to give it the benefit of the doubt.
“Until the dust had well and truly settled, investors might be very unwilling to lend to many of them at attractive rates, fearing that they might follow Greece’s lead,” he wrote.
“Even then, investors would probably worry that those 'core' countries that had stayed within the euro-zone were in for a very rough economic ride given the probable significant appreciation of the euro against the new currencies of countries that had left,” Higgins added.
No euro zone head of state would openly admit to considering a break-up of the euro, although even Germany has warned Greece it could be an option amid the battle over whether to hold a referendum on its latest bailout package.
George Soros and others have called for the ECB to be allowed buy up bondsto help lower euro zone borrowing costs and alleviate the crisis but Germany refuses to allow such a move.
Higgins believes the crisis could get a lot worse.
“Among the 'core' economies, investors may be somewhat underestimating France’s vulnerability, while overestimating that of Austria,” said Higgins, who worries both countries' banking systems are vulnerable to problems in Southern and Eastern European markets respectively.