No one can say the European Central Bank is totally ineffective. The combination of quantitative easing, ultra-low policy rates and negative interest for cash kept on deposit has reshaped the euro zone sovereign bond market. Investors suffer but governments gain. If they could take full advantage of the interest rate windfall, it could be even better news for growth.
Not only are yields on short-term paper low - 25 basis points below zero in the case of German two-year bonds - but the yield curve is flattening. Desperate investors' search for higher yields explains much of the decline. They are willing to go longer for the sake of even a few basis points. The spread between two- and 10-year German Bunds has fallen to 45 basis points, from 1.4 per cent a year ago. Such levels haven't been seen in the United States or UK since 2008.
Flat curves allow governments to borrow longer for less. Lower costs will help them meet budget targets more easily and so, spend a little more or cut debt more quickly. Both help Europe's recovery. Italy can borrow at 1.3 per cent for 10 years. If all its borrowings could be refinanced today, Rome could see its debt fall by 2.4 percentage points of GDP in 2016, while running a primary surplus of one per cent. Three months ago, the same effect would have required a surplus of 1.6 per cent.
If governments were more daring, they could increase supply and borrow a good bit more to fund needed infrastructure investment and to stimulate a still-fragile recovery. Euro zone public investment will be 2.7 per cent of GDP this year, some 18 and 25 per cent below the level in the United States and Japan respectively, according to the European Commission.
The economic logic is compelling but the politics are hostile. Fiscal restraint remains the euro zone watchword. Even if governments became more deficit-friendly, the ECB might balk, citing the legal ban on direct monetary financing of government spending. Governments will get some benefits of the ECB's low-rate world, but they're likely to miss out on the biggest potential windfall.
Not only are yields on short-term paper low - 25 basis points below zero in the case of German two-year bonds - but the yield curve is flattening. Desperate investors' search for higher yields explains much of the decline. They are willing to go longer for the sake of even a few basis points. The spread between two- and 10-year German Bunds has fallen to 45 basis points, from 1.4 per cent a year ago. Such levels haven't been seen in the United States or UK since 2008.
Flat curves allow governments to borrow longer for less. Lower costs will help them meet budget targets more easily and so, spend a little more or cut debt more quickly. Both help Europe's recovery. Italy can borrow at 1.3 per cent for 10 years. If all its borrowings could be refinanced today, Rome could see its debt fall by 2.4 percentage points of GDP in 2016, while running a primary surplus of one per cent. Three months ago, the same effect would have required a surplus of 1.6 per cent.
More From This Section
The economic logic is compelling but the politics are hostile. Fiscal restraint remains the euro zone watchword. Even if governments became more deficit-friendly, the ECB might balk, citing the legal ban on direct monetary financing of government spending. Governments will get some benefits of the ECB's low-rate world, but they're likely to miss out on the biggest potential windfall.