Italian Crisis Ambushes Ireland

European contagion threatens recent declines in Irish bond yields.

After convincing investors and the European Central Bank that it’s not Greece, Ireland may find it harder to escape the fallout from Italian turmoil.

Irish bonds lost 3.3 percent since Sept. 30, eroding the highest returns in the world since June. After falling to an eight-month low on Oct. 4, the yield on two-year Irish notes has jumped to about 80 basis points above its average of the past two months, according to data compiled by Bloomberg.

Borrowing costs for Ireland, which announced additional austerity measures last week, have risen as Italian Prime Minister Silvio Berlusconi agreed to resign to win parliamentary approval of plans to cut the region’s second-biggest debt load and Greek premier George Papandreou tries to form a unity government under a new leader.

“If the disaster scenario happens, I’m sure they’ll get hit with the same kind of contagion again,” said Haig Bathgate, chief investment officer at Turcan Connell, an Edinburgh-based manager of 1 billion pounds ($1.6 billion) for mainly wealthy clients. Current levels are “probably as good as it’s going to get until the rest of periphery Europe is dealt with,” he said.

Bathgate said he bought Irish bonds in July before selling them at the end of August.

Ireland had been distancing itself from the turmoil that ultimately cost Papandreou his job after he said he would hold a referendum on a Greek rescue package that was backed Oct. 26 by European leaders in Brussels. He later abandoned the vote plan.

The agreement “was thrown into turmoil by the decision of the Greek prime minister, and that matter appears to be clearing up now, with emphasis shifted to Italy,” Irish Prime Minister Enda Kenny said in parliament yesterday. “I expect this matter will be dealt with comprehensively.”

Yet bond yields are beginning to reflect how Ireland may struggle to stick to its budget targets as a slowing global economy threatens exports.

Two-year yields have risen 251 basis points, or 2.51 percentage points, since Oct. 4 to 9.26 percent, after declining by 600 basis points in the three months through Sept. 30. The yield on debt due in 2020 has risen 55 basis points since the end of September to 8.19 percent.

Irish bonds gained 29 percent in the three months through September, while Greek securities plummeted 25 percent, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies.

Unique Greeks

“One has to keep in mind that the Greek situation is exceptional and unique,” ECB President Mario Draghi said on Nov. 3, adding that there was “no reason to doubt the commitment” of Ireland’s government to implement spending cuts.

Irish Finance Minister Michael Noonan spoke in Dublin on Oct. 27 about how the country was “breaking the perception” that it was anything other than northern European. Ireland became the second euro member after Greece to need a bailout last November when costs to rescue the nation’s lenders, including Anglo Irish Bank Corp., ballooned.

Ireland’s outperformance is being derailed as Greece struggles to implement its aid agreement, forcing Papandreou to form a unity government with Antonis Samaras, leader of the opposition New Democracy party. Papandreou also has agreed to relinquish his post as prime minister.

Bond yields also surged across the euro area as Berlusconi tried to keep his government intact. The Italian leader yesterday offered to resign as soon as parliament approves austerity measures after he lost his governing majority.

The Italian 10-year yield climbed to 6.82 percent today, the most since the euro’s creation and approaching levels that prompted Greece, Portugal and Ireland to seek help from the European Union and International Monetary Fund.

“The analogy I’ve used is the old-fashioned rock climbers, all chained together,” said Neil Mellor, a strategist at Bank of New York Mellon Corp. in London. “One man can be springing ahead, but still be pulled back if another one falls.”

The yield spread between Irish 2020 bonds and benchmark German debt with a similar maturity was at 640 basis points today, up from 552 basis points on Sept. 30. The yield has narrowed from a euro-era high of 1,154 basis points on July 15. The Greek 10-year spread over bunds widened to a record 2,596 basis points, while Italy’s was at 502 basis points, also the most since the euro’s debut.

Efforts by Ireland to cut its deficit may also be hindered as a global economic slowdown cuts exports and tax receipts.

Budget Cuts

The country is planning an additional 12.4 billion euros ($17.1 billion) of austerity measures over the next four years, the government said on Nov. 4. Noonan is aiming to reduce the budget deficit to below 3 percent of gross domestic product, the original target to qualify for euro membership, in 2015 from a projected 8.6 percent in 2012.

The government reduced its 2013 economic growth forecast to 2.4 percent, adding that the economy will likely expand by an average of 2.8 percent between 2013 and 2015, down from an earlier forecast of 3 percent.

The Organization for Economic Cooperation and Development cut its 2011 and 2012 growth prediction for the U.S. and the euro area last month, projecting that the latter may expand by 0.3 percent next year.

“The external risks have probably gone up a bit with Ireland being a very open economy,” said Michiel de Bruin, who oversees about 25 billion euros as head of European government debt at F&C Netherlands in Amsterdam. “With the economic outlook deteriorating and people lowering growth expectations for Europe, that has been visible in the developments of Irish bonds in the last few weeks.”

Bloomberg News


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