Euro zone bond market gradually turning page on debt crisis

PARIS (AFP) - The euro zone bond market is gradually recovering from the disruption caused by the debt crisis, analysts say, with the gap in borrowing costs between fragile countries and Germany at two-year lows.

"The bond market is benefiting from both the staunch support of the ECB for one year and better-than-expected economic indicators for the past couple of weeks," said Mr Rene Defossez, a bond analyst at French investment bank Natixis.

"This cocktail is reassuring investors," he added.

A normalisation of the bond markets began in July last year when European Central Bank (ECB) chief Mario Draghi pledged to do "whatever it takes" to protect the euro and later unveiled a facility to provide massive support to countries implementing stabilisation programmes.

And the past few months have seen a series of more reassuring economic indicators, culminating with data showing the euro zone exited its record 18-month recession in the second quarter with 0.3-per cent growth. Germany managed 0.7-per cent growth and France 0.5 per cent. And while Spain and Italy still contracted, the rate had slowed.

At the height of the debt crisis, the difference - or spread - between the low borrowing costs enjoyed by powerhouse economy Germany and the ballooning rates endured by crisis-wracked Italy and Spain soared to levels seen as unsustainable.

In times of economic crisis, investors demand higher returns to lend to countries seen as less stable, as they fear they may not be paid back. This pushed up the borrowing costs for the likes of Italy and Spain.

Conversely, German borrowing costs dropped sharply during the crisis as investors scrambled to invest in Germany - seen as a safe haven amid the euro zone debt chaos. Now, however, with the euro zone seemingly over the worst of its recession and with the weaker countries sheltered by the ECB backstop, the spread, or risk premium, has dropped to levels not seen since July 2011, before the peak of the crisis.

While the gap between the bond yields of Spain and Germany was a massive 6.3 percentage points in July last year, this has now dropped to roughly 2.5 percentage points. In Italy, the spread was 5.5 percentage points in July last year and is now about 2.3 percentage points.

"The stabilisation of the economy has led to investors taking on more risk and disposing of safe-haven bonds, like those of Germany and to a lesser extent France," said Mr Christian Parisot, an economist at the Aurel BGC brokerage.

German bond yields have also been pushed up by a rise in US bond yields, which have climbed on the prospect of an imminent reduction of the monetary stimulus that the US Federal Reserve injects into the economy.

The easy money injected by the Fed pushed down US bond yields, as well in other countries as money flowed out of the United States in search of returns.

The reduction in borrowing costs for peripheral euro zone countries should somewhat relieve pressure on their finances and therefore aid their restructuring efforts - what Mr Parisot termed a potential "virtuous circle".

"We must remain cautious but we can begin to turn the page on the debt crisis. The worst is certainly behind us," he added.