Even eurozone hard core sees borrowing costs rise

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After benefitting from record-low borrowing rates during the economic crisis, the eurozone's big hitters, such as Germany and France, are seeing the financing costs rise on their suprer-size debts.

Over the past six months the yield on 10-year German bonds have risen from 2.35 percent to 3.16 percent on Monday.

The yield on French 10-year bonds has increased from 2.68 percent to 3.54 percent over the same period.

The trend is the same for the other top, triple-A rated eurozone members like Austria, the Netherlands and Finland.

"The mechanism is classic," explained Patrick Jacq, a bond strategist at BNP Paribas bank. "Once there is an anticipated return of inflation there is a tendency to lend money at a higher rate."

Eurostat said Monday that according to its preliminary estimate eurozone annual inflation came in at 2.4 percent in January, its highest level since October 2008.

Other factors are also contributing to pushing up borrowing rates for top-rated eurozone members, the so-called hard core.

"With the debt crisis throughout the entire eurozone, the most solid countries are acting as guarantors for the countries the most exposed, like Greece our Portugal," said Cyril Regnat, a bond strategist at Natixis bank.

"So they are paying for that risk," he noted, alluding to the European Financial Stability Facility (EFSF).

The EFSF is the main EU element in a joint 650-billion-euro ($1 trillion) EU-IMF rescue fund for eurozone members.

But the EFSF does not receive funds from EU members, instead borrowing money on the markets against 440 billion euros in guarantees by eurozone members, thus spreading the risk of bailed out countries across the monetary union.

Finally, a heightened appetite for risk has seen money flow to other assets, such as stocks, which has heightened tension on the sovereign bond markets.

"Investors are moving away from sovereign debt towards assets with greater risk, having been reassured by the greater clarity concerning the economic outlook," said Regnat.

The increase in borrowing rates has not made it more difficult for governments to borrow, however.

"Today's borrowing conditions remain very favourable," estimated Philippe Waechter, an economist at Natixis. He pointed out that the yield on 10-year German bonds were still considerably lower than their historical average since 2000 of 4.5 percent.

"The demand for French and German bonds remains very strong, there are no concerns," said one Paris-based analyst who asked not to be named.

But with French and German debt breaking records any sustained increase in borrowing rates would heap pressure on already strained public budgets.

In the short term, investors will be looking for clues on what the European Central Bank (ECB) intends to do.

No one expects a hike of its main rate from its historical low of 1.0 percent at its Thursday meeting, but investors and analysts will be following closely the statements of ECB chief Jean-Claude Trichet to divine when it may do so.

In tough talk in mid-January Trichet made it understood the ECB wouldn't hesitate to hike interest rates if inflation picks up.

The popular uprising in Egypt, and concerns that unrest might spread to other countries in the Middle East and affect oil supply, could also weigh on bond markets.

"It all depends on the intensity and duration of the events," said Waechter.

"If oil prices rise a little, that will add to inflation. But if they jump very sharply, to around 140 dollars a barrel for example, then that will slow the economy," which would lead to lower bond yields, he added.

© 2011 AFP

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