The EU is preparing for take-off with a € 800 billion bond issuance scheme

The EU is preparing to enter increasingly scrupulous bond markets as it embarks on the European Commission’s largest loan program.

Debt managers in the commission made calls with banks and investors this week ahead of the sale of the first bond supporting their € 800 billion NextGenerationEU recovery fund – the old new agreed last summer to finance the region’s pandemic response with joint sustained debt from Member States.

Bankers expect the deal to be priced next week, raising more than 10 billion euros from a new 10-year bond.

The sale is the latest step in transforming the EU itself into one of Europe’s largest bond issuers, and a prelude to the regular debt auction starting in September that Brussels aims to collect 80 billion for the recovery fund before the end of the year.

It comes at a time when markets have been plagued by rising inflation, and investors are speculating on when the European Central Bank will begin liquidating its 1.85 emergency bond purchase program. million euros.

“They are starting this process in an environment with rising interest rates; it is a different world than last year,” said Antoine Bouvet, senior strategist in interest rates at ING. “I don’t think anyone doubts the EU’s ability to sell this debt, but they will pay a little more to do it.”

Brussels borrowing costs have risen since October when the first bond to fund the EU’s Sure program – a smaller € 100 billion scheme to support jobs during the pandemic – met record demand. Since then, the yield on 10-year EU securities has grown 0.3 percentage points to just above zero, representing similar advances in eurozone debt markets.

“Thanks to the EU’s high credit rating, the Commission will be able to borrow on advantageous terms,” ​​the European Commission said. “The Commission will pass on the benefit directly to EU Member States when it provides them with loans or to the Union budget in the form of payments at low interest rates on loans to finance recovery costs.”

The ECB is largely expected to continue with € 80 billion a month in net bond purchases at its last policy meeting on Thursday. Even so, the issue of a slowdown in the pace of buying is likely to return later in the year as the economy recovers from the pandemic.

Markets had a taste last month of what it might look like, as speculation of a support reduction touched bond prices, pushing yields to their highest level in a year. During that period, the recent sale of EU debt has attracted weaker demand from investors in previous issues. Then, yields fell, after Christine Lagarde, head of the ECB, said it was “too early” to discuss the decline.

Brussels has already taken steps forward to become an established force in the bond markets. Prior to the launch of Sure, it had only 50 billion euros in outstanding bonds, a figure down from large national debt accumulations, such as Germany at about 1.5 tonnes, and Italy at 2.2. billion euros. But since October, the commission has collected 90 billion euros of debt in Sure, in seven transactions.

NextGenerationEU’s € 80 billion debt that the EU plans to issue in the second half of the year will make it the largest net entrepreneur in the eurozone in that period. The commission aims to raise by the end of 2026 € 800 billion for the program, with about 407 billion euros available for aid to Member States and 386 billion euros for loans. Loan volumes will average 150 billion euros per year. About 30 percent of the bonds are ultimately expected to be earmarked as green bonds to bolster sustainable finance.

Graph of monthly turnover lines (average for January 2020 = 100) showing Trade in EU bonds is growing

In addition to preparations for the loan, the commission has been working in recent weeks on detailed recovery and resilience plans for member states, in which they present EU funding and establish investments and reforms. These must then be signed by the Member States.

EU bond trading in the secondary market has increased up to 10 times since last summer, turning a relatively sleepy backwater more similar to the debt of other supranational bodies such as the European Investment Bank or the European Stability Mechanism. a market to rival Italy or France, figures from the bond trading platform Tradeweb show.

According to Michael Leister, head of Commerzbank’s interest rate strategy, Michael Leister, head of interest rate strategy at Commerzbank, said EU lending has recovered more slowly since the recent decline in prices than most eurozone debt. Uncertainty over the ECB’s policy path will give investors “more bargaining power” to demand a higher return on new debt sales, he added.

“We’ll buy it.” [the new EU bonds], especially if they offer a decent premium on Germany, ”said Paul Brain, head of fixed income at Newton Investment Management.“ But the market has a lot of issues to digest, not just the common issues through the fund. of recovery, but by individual governments ”.

Thanks to its triple A credit rating, the EU still enjoys lower financing costs than the vast majority of member states, except Germany – the last market paradise of the eurozone.

But any change in the cost of EU funding vis-à-vis Member States could be significant, Leister said. States including France and Belgium, whose long-term financing costs were slightly higher than those of the EU, might be less willing to borrow from the recovery fund if the deficit narrows.

Meanwhile, countries like Spain may be more inclined to take out loans if their loan premium grows faster than that of the EU. At the time of the situation, seven EU member states had applied for loans under the program, but the commission would remain open to loan applications until August 2023.

“It comes down to relative cost, and even a small market move changes a lot when rates are so low everywhere,” Leister said.

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