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German ‘Tough Talk’ Widens Bond Spreads, Credit Agricole Says

The yield difference between bonds from Europe’s most indebted countries and German securities may widen further unless Germany scales back its “tough talk,” according to Credit Agricole Corporate & Investment Bank.

The difference in yield, or spread, between 10-year Irish bonds and similar-maturity bunds widened to a record 554 basis points today. Portuguese 10-year bonds fell, pushing the yield up 20 basis points to 7.02 percent, the highest on record, according to Bloomberg generic data.

“The main reason why spreads have remained under pressure is not further divergence in budget fundamentals,” wrote Luca Jellinek, head of European interest-rate strategy at Credit Agricole in London. “Rather, it stems from fresh evidence that inter-government solidarity within the European monetary union remains limited and possibly fragile.”

German Chancellor Angela Merkel last month proposed a two-step mechanism to make bondholders pay for any future euro-area crisis. Her message clashes with European Central Bank President Jean-Claude Trichet, who says such talk risks exacerbating the situation for indebted euro-area nations such as Ireland and Greece as they try to narrow their budget gaps.

Bundesbank President Axel Weber said on Oct. 13 that the ECB should terminate a peripheral-bond purchase program, which was introduced to help restore order to financial market rattled by Greece’s fiscal crisis.

Investors may sell risky assets as they arrange their accounts for the end of the year, which “could further punish the peripheral ‘midgets’ unless” Germany decides to “backtrack on its tough talk,” wrote Jellinek.

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