Stay updated with free updates
just sign up sovereign bonds myFT Digest – delivered straight to your inbox.
Government borrowing costs paid by Italy and Spain have fallen to their lowest level in 16 years, more than Germany’s, as investors reward Rome and Madrid for belt-tightening and become more concerned about rising debt elsewhere in the eurozone.
The excess yield on 10-year Italian debt versus German Bunds – a closely watched measure of the risk associated with lending to Italy – narrowed to within 0.7 percentage points this month, the lowest since late 2009.
Strong economic growth in Spain has helped narrow its 10-year spread with Germany to less than 0.5 percent. That’s the lowest since before the eurozone crisis, when high debt loads pushed up both countries’ borrowing costs and raised concerns about the currency group’s breakup.
“We are seeing a simultaneous melting of the periphery with countries that were previously considered safe investments, such as France, Belgium and Austria,” said Ales Coutani, head of international rates at asset management company Vanguard. “Markets have long memories but they are also willing to turn the page when given the right incentive.”
Fund managers have warmed to Italian and Spanish debt amid a broader upturn in southern Europe’s economic health, arguing it no longer makes sense to classify such borrowers as the eurozone’s risky “periphery.”
Meanwhile, a severe budget deficit and political turmoil in France – traditionally seen as one of the bloc’s safer economies – has pushed its borrowing costs above Spain’s. Even Germany, the euro zone’s de facto safe haven, has been reassessed by markets after insisting on €1tn spending.
Vanguard’s Cotney expects the spread to tighten further next year, bringing Italy’s spread above Germany’s by 0.5 to 0.6 percentage points and Spain’s by 0.3 to 0.4 percentage points.
Investors point to Spain’s improving economic growth and Italy’s prudent fiscal policies under a politically stable government, part of a broader reduction in fiscal risks for these countries as well as other past debt hotspots such as Greece.
Ken Egan, director of European sovereign credit at ratings agency KBRA, said the improved economic situation of southern European countries means “a tale of two Europes, a tale of North and South”.
He compared the “decisive turn” away from the chronic deficits of southern European economies to sovereign countries such as France, where “chronic costs, weak growth and huge spending have weakened their fiscal position”. Credit agencies including S&P estimate that France’s debt to GDP will reach 120 percent in the next few years.
Spain is set to become the world’s fastest-growing major advanced economy in 2025 for the second year in a row. Thanks to a combination of immigration, tourism, lower energy costs and EU funds, the IMF is projecting GDP expansion of 2.9 percent for the country this year.
That increase, combined with rising tax rates, is set to reduce Spain’s deficit from 3.2 percent of GDP in 2024 to 2.5 percent this year, according to Bank of Spain forecasts.
Italy’s economy is far more sluggish, with growth projected to remain below 1 percent of GDP until at least 2027. However, investors have warmed to Prime Minister Giorgia Meloni, whose right-wing government has demonstrated a strong commitment to deficit reduction, despite pressure from workers struggling to keep up with the cost of living.
Economists say Rome is finally reaping the benefits of past efforts to curb tax evasion, increasing revenue collections.
Italy believes its fiscal deficit, which was at 7.2 percent in 2023, will fall to 3 percent in 2025, allowing Rome to exit the EU’s excessive deficit procedure faster than anticipated, at a time when Paris is exceeding borrowing targets agreed in Brussels.
In absolute terms, Italian and Spanish borrowing costs remain higher than in the era of very low or negative interest rates either side of the Covid pandemic. Overall, Italy’s borrowing costs have risen to roughly 3.5 percent this year, and Spain’s borrowing costs have approached 3.3 percent.
But trading too close to peers long considered safe bets for investors means these bonds are “entering a very different regime,” said James McElwee, head of global aggregate and absolute returns at BNP Paribas Asset Management.
“[This is]the beginning of opening up the potential global demand for those markets to investors,” McElwee said, adding that hyper-cautious managers of central bank reserve assets may start to look at the debt of Italy or Spain when investing their foreign reserves.
