Mass sell-off in euro zone bond markets

EURO ZONE bond markets suffered a mass sell-off yesterday as investor fears spread beyond Italy and Spain to AAA-rated France, Austria, Finland and the Netherlands.

The premium that France and Austria pay over Germany to borrow rose to euro-era records of 192 basis points (1.92 percentage points) and 184 points respectively, levels investors say are no longer consistent with top credit ratings.

“Markets are losing patience so they are going for the jugular, which is the core countries and not the periphery,” said Neil Williams, chief economist at UK fund manager Hermes. “There is convergence but it is convergence on the weakest.”

Mike Riddell of M&G, one of Europe’s biggest fund managers, called it “probably the most worrying day” of the crisis so far.

The rise in bond yields affected all main euro zone countries apart from Germany, and suggests that the two-year-old sovereign-debt saga could be entering a dangerous phase.

Separate figures showed the euro zone economy managed only modest growth in the third quarter of this year, with a rebound in Germany and France failing to dispel fears of a looming recession across the 17-country region.

Euro zone gross domestic product expanded by 0.2 per cent compared with the previous three months – the same pace as in the second quarter, according to Eurostat, the EU’s statistical unit.

But economists warned that the effects of the escalating euro zone debt crisis, and sweeping fiscal austerity measures across the continent, had yet to feed through and growth would soon go into reverse.

In a day that euro-era records tumbled, Italian yields moved through 7 per cent – a level viewed as unsustainable – for the second time in a week. The Spanish premium to Germany hit 482 basis points, above the critical 450 level rate at which Irish and Portuguese yields spiralled out of control and forced both countries into international bailouts.

Belgium saw its bonds’ spread over German debt reach record levels of 314 basis points.

It also emerged that negotiators for Greek debt holders have offered to swap their bonds for new ones worth half their current face value, but only if the new bonds contain high interest rates and have extra incentives, including annual payments if Greece’s economy recovers.

The offer, contained in a "confidential" proposal presented to Greek authorities on Sunday and obtained by the Financial Times, also insists the new bonds be issued under British rather than Greek law, which would prevent Athens from forcing new losses on bondholders in the future.

The talks between bondholders and Athens are scheduled to begin tomorrow in Frankfurt, where Greek officials are expected to present a counterproposal.

The negotiations are intended to finalise details of the highly touted deal struck on October 27th in which the Institute of International Finance, a consortium of Greek bondholders, agreed to take a 50 per cent “haircut” in the face value of their bonds.

Paul Griffiths, global head of fixed income at Aberdeen Asset Managers, said: “We don’t want exposure to the periphery and we are wary of buying anything in the euro zone in these markets.”

Traders said there were few buyers in many bond markets, with only the European Central Bank active in Italy and Spain.

Mariano Rajoy, the Spanish opposition leader forecast by polls to win the country’s general election on Sunday, said the next government would take the necessary measures to preserve Spain’s membership in the euro zone.

Mr Rajoy, leader of the centre-right Popular party, said: “I believe in Europe, I believe in the euro project.” – (Copyright The Financial Times Limited 2011)