It seems almost certain at this stage that the European Central Bank will raise interest rates in July for the first time in more than a decade.
The deposit rate, which has been negative for the last eight years, will likely be the first to change with a move back to zero.
The key loan rate, currently at zero, will follow or may even move at the same time.
Even before the ECB makes any gear changes, lenders have started raising the rates they seek for term loans.
While attention has focused on the impact rate hikes will have on people with mortgages and other forms of debt, movements in the global interest rate environment are already driving up government borrowing costs.
Ireland is not immune to that change in global debt dynamics.
Bonds in the era of QE
The Management of the National Treasury held a short-term debt auction this Thursday.
The interest rate to be paid for the bonds -which mature in October- was -0.25%.
In other words, the holders of those bonds are effectively paying the state for holding that debt, not the position a bondholder expects to be in.
About a decade ago, that situation would have been unimaginable.
Ireland had been excluded from the debt markets after the financial crisis that made us turn to the troika of the European Commission, the ECB and the IMF for a rescue.
Over time, we regained credibility with international lenders and gradually returned to the bond markets, borrowing at relatively high prices.
As confidence grew and the European Central Bank embarked on a policy of buying billions of euros worth of government bonds each month, a practice known as quantitative easing, or QE, the cost of servicing the debt for governments across Europe shrank dramatically.
The intent behind the policy was to encourage governments to borrow more at lower rates to boost their economies after the financial crisis and try to stimulate spending and get some inflation back into the system.
That cost of borrowing fell further during the pandemic as the European Central Bank extended the policy and began buying even more debt to encourage governments to borrow to support their economies through lockdowns.
The Irish state has benefited greatly from this broader policy, insuring ten-year debt at essentially negative rates in recent years.
The situation has changed drastically in recent months.
With inflation skyrocketing in the euro zone, the ECB announced its intention to quickly conclude its bond purchase programs in the coming months.
And it has put itself firmly on the path to interest rate hikes; some would argue that it is too late.
The effect of that is already evident in debt markets.
Having risen steadily since the beginning of the year, the price the Irish government pays to borrow on the bond markets has more than doubled since March.
The yield -or interest rate- of the ten-year debt is around 1.6%.
That is the highest cost of borrowing in that time period for the Irish state since 2014.
“By historical standards, it’s still very cheap,” Ryan McGrath, head of fixed income sales and strategy at Cantor Fitzgerald, said for context.
He noted that the National Treasury Management Agency had canceled a bond auction scheduled for June, which he interpreted as an indication that the state plans to reduce its borrowing plans for this year.
“The NTMA put out a financing statement earlier in the year that gives a range of what they can borrow from €10bn to €14bn. Historically, they have gone for the mid-point of the range, if not the upper This year, they will be at the bottom, at the end of the 10,000 million euros”, he hopes.
“It looks like Ireland will borrow less in the future, albeit at a higher rate,” he concluded.
The national debt here stood at just over €237 billion at the end of last year.
It added nearly €20bn to the position at the end of 2020, as the government continued to borrow substantially more than normal to fund pandemic-related supports.
While it is a very significant debt in real euro terms, it is usually viewed in the context of the broader economy.
As a proportion of our GDP, it stands at 56%, which is considered very manageable debt.
When compared to an indicator of economic growth favored by the Central Bureau of Statistics, a measure known as GNI*, the debt ratio stands at 102%.
Ryan McGrath said Irish debt metrics were among the strongest in Europe, reflecting rating agency Moody’s recent move to upgrade Ireland’s sovereign credit rating.
“Now we are double A in the four main rating agencies,” he said.
Anything that falls into class A is considered high quality, meaning that the debt issuer has a high probability of meeting its obligations.
Gerard Brady, Chief Economist at Ibec, agrees that Ireland is in a relatively strong position when it comes to debt dynamics.
He notes that the NTMA had taken advantage of the low rate environment to drive the overall cost of servicing the national debt to very low levels in recent years.
The blow will come on future lending, he notes, but he said the state should be able to withstand a fairly sustained rise in interest rates in the coming years, provided a number of conditions are met.
“You would have to see lending rates at elevated levels for an extended period of time, around 4 or 5%, to see any real pressure on the government’s interest bill, as long as we don’t run big deficits.” He explained.
How high could government borrowing costs rise?
It seems virtually certain that interest rates will rise in the coming months and years, putting upward pressure on the cost of borrowing for individuals and governments.
Aside from the ECB’s base rate and the fundamentals of the bond markets, much depends on a country’s perceived reliability and ability to service its debt.
The riskier a country is perceived to be in terms of borrowing, the higher the interest rate that is usually attached to the debt.
It is not an issue that should concern the Government at this time, but for some countries it could be a problem.
“As the ECB retreats, you can see bond yields expanding,” notes Gerard Brady.
“The whole talk about structural reform was really just a trick of the ECB doing a lot of the buying [of bonds] in Europe,” he explained.
Attention is likely to return in the coming years to the so-called ‘spread’ between Germany’s borrowing costs and the rate applied to other countries.
That could see a resurgence of tensions between countries over what is considered an appropriate interest rate and southern European states’ view that the ECB needs to do more to help them.
“Italy has been expanding, but it’s been pretty orderly,” said Ryan McGrath.
“There have been no major shocks. The spread between Italy and Germany is around 2%. What the ECB would not want is a volatility shock where Italy would explode very sharply and sustainably,” he said.
Investors have generally been reassured by Italy’s relative political stability since Mario Draghi became prime minister early last year.
There are some concerns that this stability could be disrupted when elections are held next year.
Already dealing with inflation, rising interest rates and the prospect of a recession, the last thing the ECB wants right now is the prospect of another debt crisis in Europe.
Crisis or not, the truth is that we are entering a new era of high interest rates that an entire generation of Europeans will never have experienced in their lives.
“The scale of the interaction in the economy has been huge, and as it regresses and normalizes, it’s going to feel very different,” Gerard Brady said.
“We have lived through this unreal moment in terms of interest rates. For now, it seems that we are returning to a reality prior to the financial crisis with rates on the rise, at least in the short term,” he concluded.