Something pretty amazing has just happened: the interest rate on Irish government bonds (at least, the 10-year bonds we tend to focus most on) dropped beneath those on the UK’s. It’s the first time this has happened since late-2008, and raises a tantalising question: is Ireland now more of a safe haven than the UK (in investment terms)?
After all, for most of the past half-decade, the interest rate on government bonds has been looked at as a yardstick of financial health. If an investor is extremely worried about a borrower defaulting, they will insist on a higher interest rate in return for a loan. Hence when it looked as if eurozone nations were set to default (and in some cases did default) their bond yields (implied interest rates) rose to extraordinary, double-digit, credit-card style levels.
Ireland’s 10-year bond yield has fallen from peaks of around 14% in 2011 to a mere 2.651% earlier today. Britain’s 10-year bond yield is 2.684%.
So does this mean Ireland is judged as less likely to default than the UK? The short answer is no. If you have a look at another measure of investor concern about a particular nation defaulting – credit default swaps – Ireland is still far riskier a proposition than Britain. Irish CDSs – a kind of insurance policy on the prospect of a borrower defaulting – remain significantly higher than Britain. Again, though, they have come down significantly since the height of the crisis.
It is clear – in particular from the chart above – that the heights of the euro crisis are long behind us. If anything, one can date this from the moment European Central Bank president Mario Draghi pledged, in a summer 2012 speech in London, to do “whatever it takes” to prevent a euro collapse. There is no longer a widespread fear of systemic currency implosion.
But this doesn’t explain why, suddenly, Irish bonds are trading at lower interest rates than the UK. To understand why, one must recall that bond yields aren’t just a measure of solvency. They are also a measure of return. Ignore, for a moment, the possibility of default: if a country is likely to be growing faster, with higher interest rates, then that implies greater returns from anyone investing in their currency and government bonds. So all else being equal (and in the absence of significant worries about imminent default), higher bonds can signify more growth potential.
As it happens, Britain is growing very fast at the moment and the Bank of England is expected to raise interest rates within the next year. The eurozone, on the other hand, is facing sluggish growth and possible deflation; the ECB is poised to take further action to try to stimulate the economy. In other words, we have two different economic areas which are heading in opposite directions right now.
The euro crisis is indeed over (though it’s transmogrifying into a long-term politico-economic crisis – a subject for another day). It’s been over for some time. But the recent movement in bond yields is telling us an entirely different story: one in which higher interest rates might actually be a good sign rather than a bad one.