Bond investors are exacting a heavy price from three of Europe’s largest economies, which are struggling with a credibility crisis as the Iran conflict thrusts government borrowing back into the spotlight.
“Britain, Italy and France have now become nations where spreads to what we’d call core nations — such as the U.S. and German government bonds — have been widening where there’s been concerns about inflation and how effectively these sovereigns play their way out of it,” said Craig Inches, head of rates and cash at Royal London Asset Management.
Collectively dubbed the ‘BIFs’ — a throwback nod to the so-called ‘PIIGS’ (Portugal, Ireland, Italy and Spain), the problem children of the 2011 European sovereign debt crisis — Britain, Italy and France each face their own set of unique challenges.
While the 2011 euro crisis centered on solvency issues, governments in London, Rome and Paris now grapple with a credibility challenge — and investors are increasingly grouping them together as the new fiscal misbehavers.
Yields on 10-year gilts, the benchmark for U.K. government borrowing, stood at 4.865% on Tuesday, while yields on France’s 10-year OAT was 3.6388%, as Italy’s 10-year bonds yielded 3.7693%.
By comparison, the yield on U.S. 10-Year Treasurys were 4.2876%, while in Germany, 10-Year bund yields stood at 2.999%. A similar theme is seen across the maturity curve.
“If you look at the three nations, independently they’ve all got their own issues,” Inches told CNBC’s “Squawk Box Europe” on Tuesday.
Following the 2024 election, France was effectively left with a hung parliament. It has lurched from crisis to crisis, with government decision making and efforts towards structural reforms severely restricted.
Italy, in contrast, has a “more stable government than they’ve had for many years” under Gioriga Meloni, Inches said. “But they have a very high debt-to-GDP, so they almost can’t afford to increase their debt, and their deficits are rising.”
U.K. 10-Year Gilts.
The U.K., meanwhile, has the lowest debt-to-GDP ratio in the region, and a Labour government with a very large majority in parliament. But Keir Starmer’s government faces a credibility issue among lenders, said Inches.
“A large proportion of the debt the U.K. raises goes towards debt servicing costs and to the welfare state,” he said, adding that recent “political shenanigans” are causing concern among investors. “When people lend to the UK there is concern where their money is being spent.”
The war in the Middle East has pushed shorter-term debt yields higher amid fears of an immediate inflation shock. But Inches said the continued structural pressures faced by the BIF countries will also push up longer-term yields.
France 10-Year Bonds.
“Ultimately, what you would have expected to see is the impact of demand destruction in the future and you’d expect to see long-dated bonds either stay where they are or start to decline slightly in yield as markets priced in lower interest rates in the future,” Inches said.
“But we’re not seeing that now — we’re actually seeing higher yields in longer-dated bonds.”
The countries are attempting to address this issue by effectively shortening the maturity of debt issuances, and cutting the amount of longer-dated government borrowing in a bid to ease longer-term costs. However, the premium paid on borrowing costs by BIFs countries remains high.
“If economies cannot really grow their way out of this, or ultimately inflate their way out of this, then it means that future supply may need to come at higher yields, ” he said. “Investors are demanding higher-term premia to lend to these sovereigns for longer dates.”
Italy 10-Year Bonds.
