Photographer: Alberto Pizzoli/AFP/Getty Images

Don't Forget the Irish When Looking at New Risks in Euro Region

  • Portuguese and Spanish bonds decline after inconclusive votes
  • Coalition in Dublin may lose majority in election, polls show

Ireland gets to decide on its next government as early as next month, and if elections in other countries once at the heart of the European debt crisis are anything to go by, investors should be wary.

Portugal’s vote on Oct. 4 produced an inconclusive result, leading to weeks of brokering before Socialist leader Antonio Costa took power with promises to put the brakes on austerity measures. Bond yields have jumped to the highest in six months since then. In Spain, Prime Minister Mariano Rajoy lost his majority last month after years of belt-tightening and the country still doesn’t have a new government.

Ireland is another European electorate jaded by budget cuts. Polls indicate that Prime Minister Enda Kenny’s ruling coalition will struggle to win a majority, though there’s no clear alternative. The country, European Central Bank President Mario Draghi’s model for economic recovery, saw its 10-year bond yields sink below 1 percent this month. But banks and brokers are already sounding warnings.

“The ballot is the most important potential flash-point of the year,” said Dermot O’Leary, economist at Goodbody Stockbrokers in Dublin. “Investors got caught out by the inconclusive result in Spain, and so there is more focus now on Ireland.”

With investors also spooked by Portugal’s move to imposes losses on some investors in what’s left of a failed bank, the nation’s sovereign securities have been the worst performers in the euro zone this year after Greek debt.

Yields on 10-year Portuguese bonds were above 3 percent last week, up as much as 80 basis points since the election. Spain’s, by contrast, were little changed compared with before an election on Dec. 20, at 1.71 percent. Ireland pays less to borrow than any of the so-called peripheral euro nations. Its 10-year bond yields were at 1.04 percent on Monday in Dublin, looking more like France or Belgium than a riskier credit.

‘Hard Work’

Kenny, 64, has yet to call the Irish vote, but it must be held by early April and there are some expectations he will name the date next week. All the major parties are promising to relax the austerity that helped Ireland regain in its economic sovereignty, a pledge that resonated in Portugal and Spain and split the electorate.

“Ireland’s strategy in recent years has been to under-promise and over-deliver on the budgetary front,” said Alan McQuaid, an economist at Merrion Capital in Dublin. “The last thing the country needs right now is some bad political mis-management, which could jeopardize all the hard work.”

Since Kenny swept to power in 2011 after the country was forced to seek an international bailout just months earlier, Ireland’s recovery was underpinned by spending cuts and tax increases equivalent to about a fifth of the economy while the bond market rallied also with the help of the ECB’s monetary stimulus.

Combined support for Kenny’s Fine Gael-Labour alliance dropped two percentage points in January to 39 percent, the Sunday Business Post said, citing a Red C poll. To win a second term, it needs to win about 44 percent, according to Philip O’Sullivan, an economist at Investec Plc in Dublin. The two parties together won 55 percent in 2011.

Who Else?

The problem for the opposition, and perhaps investors, is no clear alternative has emerged to Kenny’s coalition.

Support for Fianna Fail, once one of Europe’s most successful parties at the ballot box, is hovering at about 20 percent. Its leadership has so far ruled out governing with Kenny or Sinn Fein, the former political wing of the Irish Republican Army that’s turned into an anti-austerity crusader and led the polls as recently as a year ago.

“The general elections in southern Europe in 2015 produced some significant surprises and a muddled political situation,” Jens Peter Sorensen, chief analyst at Danske Bank A/S in Copenhagen, said in a note to clients last week. “The upcoming election in Ireland could produce a similar result.” It could contribute to “short-lived” volatility in Irish government bonds, he said.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE