Europe News

Debt crisis 2.0? Worries return to Europe as ECB could be forced to continue with stimulus

Political instability in Europe is widening yield spreads and revamping fears over debt sustainability across the region, leading to speculation that the European Central Bank will need to continue with its ultra-loose monetary policy.

The risk premium on French bonds has returned to their 2012 crisis levels. Greece is once again making headlines, with growing concerns that the country will not be able to pay back its debt, which is mostly owned by the European Central Bank (ECB). Italian sovereign yields have risen as the country seems closer to snap elections. Spain could see the region of Catalonia making another bid for independence. Brexit negotiations should also kick start next month but the list goes on and on.

Amid so much uncertainty, investors are getting nervous and German sovereign bonds – known as bunds – are becoming a "buy" option, according to some.

European political environment increasingly polarized: Commerzbank
European political environment increasingly polarized: Commerzbank

"There's a fairly lengthy list of events and the lengthier it is, the more support for bunds, thanks to their safety and liquidity," David Schnautz, director and interest rate strategist at Commerzbank, told CNBC on Monday. He added that at their current level, bunds can actually be "quite a good buy."

More ECB QE?

The French presidential election seems to be the biggest concern at the moment given how unclear the outcome of the May vote is. Last Tuesday, the French and the German 10-year borrowing costs widened to 78 basis points, the highest level since November 2012. However, according to Commerzbank, even after the vote, most investors' concerns won't necessarily be solved.

"Risk premia on French government bonds are back up to the levels seen during the 2012 crisis. But even if Marine Le Pen (the leader of the far right) does not win the French presidential election, the real problem of monetary union would remain: Different approaches to economic and monetary policy," Joerg Kraemer, chief economist at Commerzbank, said in a note on Monday.

"Radical euroskeptics are no longer in the mood for compromise, and are pushing to restore full national control over economic and monetary policy. More tumult lies ahead for the euro zone, with no end in sight for the ECB's loose monetary policy," he added.

According to Kraemer, if investors continue to grow nervous and European finance ministries have trouble selling debt, governments will call on the ECB to continue its monetary stimulus.

Damaging debt default?

Something has to give on Greek debt: Pro
Something has to give on Greek debt: Pro

Another current and ongoing headache for European officials is the high Greek debt burden. The country is once again at odds with creditors on the implementation of austerity measures, increasing the chances that Athens may default on its own debt in July when repayment deadlines hit.

"The amount (of) outstanding bonds with private investors is only to the tune of 17 billion euros ($18 billion) , that's very small relative to the overall stock of debt outstanding, and the majority is indeed with the European Central Bank and that's what the problem is, because any debt forgiveness would involve the European Central Bank and that smells very much like monetary financing which is, you know not entirely approved by the (European Union's) Maastricht Treaty so that's what the discussion is about," Mary Pieterse-Bloem, global head of fixed income at ABN AMRO private bank, told CNBC on Monday.

The Greek debt-to-GDP (gross domestic product) ratio is expected to have increased from 177.4 percent in 2015 to 179.7 percent in 2016, and is estimated to then start declining in 2017, the European Commission said Monday.

According to Pieterse-Bloem, the current impasse between European creditors and the Greek government should be overcome, but only when Athens can no longer refuse doing what creditors want in exchange for fresh funds.

The impasse will be ended in the same way as it ended in 2015. "We are at the exact same spot, only at a higher GDP level," Pieterse-Bloem added.

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