As Rates Near Their Peak, the Pain Begins for Europe's Borrowers
European borrowers face repayment on trillions of euros of debt sold when financing costs were many times lower.
Interest rates may be peaking in Europe, but for the consumers, companies and governments that borrowed trillions of euros during the era of ultra-low borrowing costs, there’s still plenty of pain in store.
Through the end of this decade, borrowers across the continent face repayment on a mountain of debt sold when financing costs were many times lower. Although the adjustment is painful in many places, including the US, it’s a particular shock in Europe, where interest rates were below zero for eight years. Many borrowers have delayed refinancing in the hope that rates would come tumbling down again. But with economies having largely performed better than expected, that’s looking increasingly unlikely.
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Investors predict that the coming years will be marked with defaults and spending cuts as a larger portion of corporate, household and state income goes into financing debt. A stark indicator of the approaching sea change is the gap between what governments and companies globally are currently paying in interest and the amount they would pay if they refinanced at today’s levels. Apart from a few months around the global financial crisis, the gauge has always been below zero. Now it’s hovering around a record high of 1.5 percentage points.
“If your bet was the 2010s was the new normal where rates kept falling and you can always refinance, this is a really difficult environment,” said Mark Bathgate, a former Goldman Sachs Inc. and BlueBay Asset Management investor who now runs his own advisory firm. “The issues in European credit could be a lot worse than in the US. There was a lot more scope for excessive leverage to be built up. ”
Milton Friedman first coined the idea of long and variable lags in monetary policy in the 1960s. Put simply, it’s the uncertain lapse of time before changes in monetary policy start to impact the economy. While the price of assets such as government bonds often moves in anticipation of, or immediately after, a central bank decision, it takes time for rate shifts to feed into longer-term contracts, and so into price-setting, labor markets and, eventually, inflation.