European Finance Chiefs See ‘Worrying’ Trends in Bond Markets

By Meera Louis

Feb. 9 (Bloomberg) -- European finance ministers are increasingly concerned that certain governments are finding it harder to borrow in financial markets as budget deficits mount and economies slump, according to a confidential report prepared for this week’s Group of Seven meeting.

The widening gaps between the interest rates different euro- area nations must pay bond investors are “worrying developments,” according to a “speaking note” prepared for Luxembourg Finance Minister Jean-Claude Juncker. Ministers also are concerned about weak demand at some government bond auctions, according to the document. Juncker will represent counterparts from the euro-area nations at the gathering of G-7 finance chiefs on Feb. 14 in Rome.

The split between the rates Spain, Italy, Greece and Portugal must pay in financial markets to borrow for 10 years and the rate charged to Germany ballooned this year to the widest since before they joined the euro. That is threatening to hobble the recovery of the region’s weakest economies and even raising doubts about the future of the single currency bloc.

“These developments highlight the need for member states to take budgetary sustainability into account when devising and implementing rescue measures,” according to the note, which was obtained by Bloomberg News and prepared for Juncker by officials at Europe’s finance ministries and central bank.

Fiscal Imbalances

The need to combat the worst downturn since World War II is forcing governments to run up deficits throughout the 16-nation euro region. The European Commission predicts budget shortfalls this year of 11 percent in Ireland, 3.7 percent in Greece, 6.2 percent in Spain and 3.8 percent in Italy, compared with 2.9 percent in Germany.

The fiscal imbalances are being reflected in financial markets and in the reviews of credit rating companies. The difference between the Spanish and German 10-year bonds last month reached the highest since 1997. The spread on Italy’s bond rose to the most in 12 years and the Greek spread was the biggest since 1999.

Standard & Poor’s last month cut the sovereign credit ratings of Portugal, Spain and Greece and reduced the outlook on Ireland’s rating to negative from stable.

The increase in funding costs reflects an increased “expectation of higher future global bonds supply, less favorable fiscal positions and a relative lower liquidity on the secondary markets,” according to the note prepared for Juncker. He will lead talks of euro-area finance ministers in Brussels today.

Financial Crisis

While the report said the priority for U.S. policy makers is to end the financial crisis and recession, it said it would be “key to withdraw both fiscal and monetary stimulus in a timely way” to prevent it creating future asset bubbles.

It advised Japan to also close its budget deficit and raise interest rates once the crisis passes so as to anchor inflation expectations and to “move the yen back in line with fundamentals.” It called China’s management of its exchange rate “restrictive.”

The report said the outlook for the world economy is “exceptionally uncertain,” although it cited falling fuel prices and the financial rescue packages as sources of confidence. Deteriorating trade is adding to the weakness, the report said. Volkswagen AG, Europe’s biggest carmaker, said deliveries fell about 20 percent last month.

To contact the reporter on this story: Meera Louis in Brussels at mlouis1@bloomberg.net.