Debt will have to be cut as interest rates rise, warns EU watchdog

Raising interest rates and ending emergency bond buying could have “marked implications” for high-debt EU member states, the Union’s budget watchdog has warned.

Moving towards a normal [interest rate] policy mix may prove challenging for the European Central Bank,” said a report from the European Fiscal Board (EFB) yesterday. 

“It can also have marked implications for sovereign bond yields. Due to the high level of indebtedness of some member states, a sharp rise in government bond yields could trigger a reassessment of sovereign risks, and have implications for the financial stability of the euro area.”

Niels Thygesen, the EFB’s chair, said governments should do more to reduce debt, which would help central bankers in their bid to curb inflation.

“It would assist monetary policy if there were more signs that sustainability on the fiscal side was being taken very seriously by the financial authorities,” Mr Thygesen told reporters in Brussels.


Niels Thygesen, chair of the European Fiscal Board

“I think the ECB is hinting also that more support for their anti-inflation objective would be helpful, and more emphasis on sustainability would also be helpful in containing inflation.”

The ECB is set to raise interest rates by 0.25pc next month, after winding up its bond-buying programme, with a further rate rise due in September.

Ten-year bond yields – the premium investors charge to buy debt from governments – spiked on the announcement, particularly on bonds issued by Italy, Greece and other weaker eurozone economies.

While Ireland’s national debt is at an all-time high, Irish bonds are not in the spotlight – largely because the closely watched debt-to-GDP ratio has been flattered by strong growth, including that linked to multinationals based here.

Xavier Debrun, a member of the EFB and an adviser at the National Bank of Belgium, said the rise in yields was normal.

“On the financial stability side of things, yes, there is always a fear when you see those doom loops re-emerge,” he said. “But what we see on the bond yields is completely expected. Frankly, I’m not too worried.”

However, he warned the EU not to suspend debt and deficit rules indefinitely, as it would cause “policy uncertainty” at a time when investors are “waking up to sovereign risk”.

During the pandemic, the EU suspended the rules, which cap deficits at 3pc of economic output and debt at 60pc. The EU recently extended the suspension through 2023.

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