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A strong and credible market There is nothing which demonstrates the credibility of the Austrian bond market better than the minimal spread between Austrian and German treasuries. Before the latest National Council elections in December 1995, the spread was 40 basis points. A spread of 30bp is considered normal, due to the fact that the Austrian market is not as liquid as its German counterpart. Currently the spread amounts to only a few basis points. International investors obviously consider Austria a natural participant in the coming European monetary union. The primary reason for this judgment is, of course, the fact that the Austrian schilling has been pegged to the German mark for years, which means Austria has successfully, if unofficially, participated in the former European Monetary System. There was a significant interest and yield premium paid by Austria when it began its hard currency policy in the seventies. Since that time key figures for the Austrian economy have made impressive progress, closely matching those of Germany. Low growth, inflation and interest rates Current forecasts for economic growth have again been lowered. Real GDP growth of 1% is expected this year, and growth of somewhat over 1% is expected next year. In particular the domestic demand components comprising private consumption and investments have lost much of their dynamism; foreign demand is now the driving force behind economic growth. This situation will improve when there are clear signs of economic recovery in Europe (particularly in Germany). Austria’s budget consolidation program, which will reduce the federal deficit in line with the Maastricht criteria from 5% of GDP (1995) to 3.8% (1996) and then to 2.7% (1997), will be one of the decisive factors affecting 1996 and 1997. The rate of inflation has declined considerably: it amounted to 2.2% in 1995 and is expected to total 2.1% this year. Yet in view of first quarter developments, it could actually fall below 2% this year. The inflation rate in 1997 will be less than 2% in any event. The Austrian National Bank – like the German Bundesbank – has reduced key interest rates to the spectacularly low level of 2.5% at mid-April 1996. Recent steps taken by the Bundesbank to lower interest rates were somewhat surprising in view of the fact that M3 is exceeding both expectations and the central bank’s target corridor. Thus the Bundesbank´s actions are to be viewed as measures designed to stimulate economic growth and investment. The former goal can only be achieved, however, if the bond market reacts favorably to the measures reducing interest rates. This was attempted by leaving the repo rate in Germany unchanged at 3.3%. Due to this decision, the spread between German discount and repo rates widened to 80 basis points. This means that investors still expect a further decline in the repo rate, which is an important factor for performance on the bond market. Thus future developments on Deutschmark as well as Austrian schilling bond markets may very well be viewed positively in light of the monetary measures implemented last month. The Austrian money market continues to show a high level of liquidity, which recently led to rates falling below Deutschmark reference rates. Money market rates in Austria will decline further following possible repo rate cuts in Germany, but the negative differential with German rates will not necessarily remain. Bond yields, which peaked at the beginning of March, have fluctuated strongly on a day-to-day basis but the trend has clearly been toward lower yields. As in Germany, bond yields in Austria face a further decline on account of the money market’s continued expectation of interest rate cuts. Only toward the end of 1996 will this be replaced by upward movements, assuming that the current vague expectations of economic growth become more concrete. A solid currency The Austrian schilling/Deutschmark currency risk remains negligible. Regardless of the status of Euro discussions, the Austrian National Bank will continue to pursue its present foreign exchange policy. Austria’s participation in Emu at the earliest possible date seems assured in view of the government’s planned fiscal measures. Given the Austrian schilling/Deutschmark linkage, the US dollar will continue to appreciate relative to the schilling this year, before levelling out within a twelve-month period. The expectation that the short-term dollar/Deutschmark interest rate spread will again expand, is an important factor determining the development of the dollar. As long as this situation continues, exchange rates in Europe will be relatively stable, leaving aside any potential turbulence related to the Euro discussions. A bond market of record size Bonds are the most important instruments on the Austrian capital market. The outstanding volume of bonds has increased dramatically during the last two decades to stand at Sch1.401 trillion at the end of 1996, about 59% of estimated 1995 GDP. Central government is the largest single issuer of bonds, with 44% of the outstanding volume. The annual gross issue volume of central government bonds has increased steeply in recent years and reached a peak of Sch115 billion in 1995. The Austrian Federal Financing Agency intends to place Federal bonds totalling between Sch110 billion and Sch120 billion in 1996, so that a new record is likely to be set. In order to increase market liquidity, it will issue as much debt as possible by re-opening existing issues, taking account of the redemption calendar and the permitted band of 98-102 when setting the average price. |
