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Irish Yields Fall Below Italy’s Ignoring Deficit: Euro Credit

Ireland has been functioning thanks to rescue loans since 2010. The government has nationalized five banks and the country’s budget deficit will exceed 8 percent of output this year, European Union forecasts show.

In Italy, the budget shortfall will be 2 percent, less than the EU ceiling of 3 percent of the gross domestic product, and it hasn’t had to bail out its banks. Even with this economic backdrop, bond markets show investors have more confidence in Ireland than Italy.

Irish rates have fallen below those of Italy across much of the yield curve for the first time since 2009.

“Italy is getting the full brunt of contagion from Spain, and the markets are all playing the game of ‘who’s next?’,” said Cyril Regnat, a fixed-income strategist at Natixis in Paris. “Ireland has benefited from a positive news flow recently, but you still have to consider that markets are being a bit abnormal.”

Italian nine-year bonds yield 6.62 percent, their highest since January. Rates on Irish securities of the same maturity are 6.34 percent, near their lowest since late 2010. In mid- 2011, Irish nine-year bonds yielded 993 basis points more than Italy’s. Ireland doesn’t have a 10-year bond trading.

Ireland has borrowed at preferential rates from its EU partners for the past 20 months, and market prices don’t reflect what it would pay if, like Italy, it had to fund itself in markets, said Guillaume Menuet, head of western European economic research at Citigroup Inc. in London.

Market Pressure

“Ireland doesn’t borrow on the market, so there’s not the same supply and demand dynamic,” Menuet said.

Ireland also has benefited from speculation that it will share in the EU’s June 29 agreement to refinance Spanish banks directly, without boosting the country’s sovereign debt.

“If they apply the deal Spain got to Ireland, then you have a game changer for their sovereign debt dynamic,” said Ken Wattret, chief euro-zone market economist at BNP Paribas SA in London. “The debt trajectory then looks a lot different, and a lot more favorable for Ireland compared to Italy.”

The bank nationalizations and the recession that followed the end of its real-estate boom boosted Ireland’s sovereign debt to 116 percent of economic output from 25 percent in 2007, according to EU figures. About 40 percentage points of that debt came from propping up banks. It could come off the government’s books, depending on what arrangement it reaches with the EU, Wattret said.

Rising Debt

Italy’s debt rose to 123.5 percent this year from 103.1 percent of GDP in 2007.

Italy is handicapped by politics. Prime Minister Mario Monti, the university dean who became head of a technocratic government last November and has pushed though tax increases, spending cuts, and changes to labor laws, says he won’t stay beyond elections that must be held early next year.

Italy will run a primary budget surplus, or surplus before interest payments, of 3.4 percent this year, the highest in the euro zone, the commission forecasts. Ireland’s primary deficit will be 4.3 percent, the highest in the 17-country bloc.

“It depends whether you focus on the stock or the flow,” Wattret said. “If you look at the stock, it favors Ireland. If you look at the flow, it favors Italy.”

Ireland’s yields trading below Italy’s is a sign of how dysfunctional the sovereign debt market has become, along with negative bond yields in countries such as Germany and Denmark, said Erik Nielsen, global chief economist at UniCredit in London.

Yield Divergence

While yields on two-year Belgian, French, Austrian, Dutch and Finnish securities have declined this month, Italian rates have been rising along with those in Spain. Two-year Spanish rates rose above 7 percent today for the first time in the euro era.

Spain’s deficit will be 6.4 of economic output this year, with a primary deficit of 3.3 percent, the commission says. Spain’s debt, which will rise to 72 percent of output this year from 40 percent in 2008, remains smaller than Italy’s.

“The political outlook is very uncertain,” BNP’s Wattret said. “Fundamentals aren’t driving this market, sentiment is.”

To contact the reporter on this story: Gregory Viscusi in Paris at gviscusi@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net

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