Brexit fear is starting to reopen the euro zone's sovereign wounds. France's bond yields are rising while Germany's are falling. It's a warning from markets about what could await the euro zone if the UK leaves the European Union after the June 23 referendum.
The moves in euro zone government debt markets are small compared to 2011, when the euro zone nearly fell apart, but they show markets are not treating euro zone debt equally. Investors are now willing to pay to lend to the government in Berlin for 10 years - which is to say, yields on its debt are negative. But they are charging Paris relatively more to borrow. The French 10-year spread over Germany is the highest since mid-February, when markets were spooked over trouble in the Chinese economy.
There's no doubt Brexit would be bad for the rest of the European Union (EU). The bigger issue is whether it would trigger copycat referendums. Were that to happen in a euro zone country - France, say - it could trigger the break-up of the whole bloc.
If break-up risks start to materialise, the European Central Bank (ECB) isn't powerless. It could hoover up bonds more aggressively, and hand money out directly to citizens. Yet such quasi-fiscal measures may stir even stronger anti-EU sentiment in creditor countries. Markets will also worry about the size of governments' liabilities to the ECB in the event of a break-up if deposits fly out of weaker countries into stronger ones.
Market panic has persuaded governments to take difficult decisions before. Fear may lead euro governments to offer the UK an olive branch. But for that to happen, markets may need to get rowdier.
The moves in euro zone government debt markets are small compared to 2011, when the euro zone nearly fell apart, but they show markets are not treating euro zone debt equally. Investors are now willing to pay to lend to the government in Berlin for 10 years - which is to say, yields on its debt are negative. But they are charging Paris relatively more to borrow. The French 10-year spread over Germany is the highest since mid-February, when markets were spooked over trouble in the Chinese economy.
There's no doubt Brexit would be bad for the rest of the European Union (EU). The bigger issue is whether it would trigger copycat referendums. Were that to happen in a euro zone country - France, say - it could trigger the break-up of the whole bloc.
Also Read
The euro zone has lines of defence. One is to push for the ability to take tax raised in one country and spend it in another. That would trigger a backlash in relatively rich northern Europe. The second is to punish the UK as much as possible by hitting it with trade tariffs. The most plausible response would be to buy time with a fiscal stimulus and restructuring of some aspects of the EU, such as fiscal policy and possibly the free movement principle. This may also require debt restructuring, as many governments are already over-indebted.
If break-up risks start to materialise, the European Central Bank (ECB) isn't powerless. It could hoover up bonds more aggressively, and hand money out directly to citizens. Yet such quasi-fiscal measures may stir even stronger anti-EU sentiment in creditor countries. Markets will also worry about the size of governments' liabilities to the ECB in the event of a break-up if deposits fly out of weaker countries into stronger ones.
Market panic has persuaded governments to take difficult decisions before. Fear may lead euro governments to offer the UK an olive branch. But for that to happen, markets may need to get rowdier.