Spread bet

ECB quest to even out euro credit costs is working

Quantitative easing should narrow the Eurozone's great credit spread divide. The yawning chasm between borrowing rates in core states like Germany and peripheral economies like Italy has been arguably the bloc's biggest headache. Bond-buying, announced officially on January 22, could supercharge a thawing that is already under way.

Funding costs in the zone's weakest countries fell in 2014, fuelled by European Central Bank (ECB) rate-cutting, cheap long-term bank funding, and purchases of private-sector debt. The average Italian company paid 80 basis points less to borrow in November 2014 than a year earlier. They paid 90 basis points more than German peers, against 1.47 per cent a year earlier.
 
The ECB's pledge to buy euro 1.1 trillion of government and other bonds through 2016 should ramp this up. The Crossover index, which includes credit swaps on high-yield debt, has fallen 33 basis points since mid-January, Markit data shows. Spreads across bond markets will likely fall, as yields on low-risk government debt sink. As investors are pushed into buying riskier sovereign debt or corporate bonds, peripheral credit conditions should improve.

Banks are also in a better place. While the ECB's asset quality review was inevitably flawed, lenders are now in general less capital-constrained. Meanwhile, the central bank's purchase of asset-backed securities is helping the securitisation market. The spread on AAA-rated bonds pooling Spanish small company debt has fallen by 85 basis points in a year, JPMorgan analysts say. Bankers have also been busy selling bonds backed by Italian property loans. As lenders become more able to shift risks off their balance sheets, they will feel happier lending. If they don't extend credit, they will earn almost nothing from government debt, and less than nothing keeping money on deposit, thanks to the ECB's negative rates.

The missing link is consumer demand for credit, which has been lacklustre during the crisis. Yet companies' and households' desire to borrow started to pick up last year, and recent European lending surveys point to the highest demand for loans since 2007, according to UniCredit. If demand can match supply, current forecasts for growth, predicted to be 1.2 per cent by the International Monetary Fund, could start to look pessimistic.