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European government bonds: Times breed unconventional wisdom

Unprecedented high spreads between European government bonds are prompting some radical – and frankly unworkable – new ideas.

The levels of risk aversion among investors has precipitated a flight to quality that has forced spreads on European government paper to worrying levels. Italian BTP yield spreads are almost 100 basis points over benchmark German bunds. Ten-year Greek issues are now 120bp above their German counterparts. With funding this expensive for non-core European sovereigns, the European Primary Dealers Association (EPDA) is revisiting an idea first discussed in 2000: a common European government bond. The EPDA argues that since the government bond markets have become so fragmented the benefits of such a product are increasingly apparent, especially to the smaller, lower rated issuers.

The association outlined in a September discussion paper six possible instrument types. The first would comprise the total annual issuance of the 15 euro area sovereigns, accounting for €1.5 trillion a year. Such a programme would be rated A/A/A1, according to the association. The second option is the same but with a guarantee fund administered through an agency, bringing the rating to triple-A. The other options include issuance programmes that only account for 50% of the annual funding of the sovereigns and issues that exclude the core markets of Germany and France.

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