25th November 2011
But it will be a surprise to the German authorities, used to a rich supply of buyers for their bonds. The German authorities have generally refused to ‘market' their bonds in the same way as other countries. It is therefore worth considering whether the seeds of a solution to the Eurozone crisis might be planted within this news. Could it force Germany's hand and propel them towards supporting the quantitative easing that – many suggest – the Eurozone so badly needs?
Mindful Money blogger Shaun Richards argues that it is little surprise that there was limited demand for German debt today, arguing so-called ‘safe haven' countries will soon see their yields rise: "You see in many ways it is more of a surprise to me that anyone would accept an interest-rate of 1.98% for ten years in these "expect the unexpected" times than some have turned it down." This implies a permanently higher yield on German bonds, which may yet spook the authorities into action on QE.
To date, however, the failed auction has not made a significant difference to the overall yield on bunds, pushing it a little over 2% for 10 years. It may be symbolically important that it has risen marginally higher than the yield on the 10 year gilt, but its immediate impact is minimal.
Also, unlike many of its Eurozone neighbours, Germany does not have significant immediate financing needs. This article from September says: "Germany announced a drop in its public deficit to a three-year low on Thursday as the economy reaches pre-crisis levels and in stark contrast to the debt crisis overhanging the eurozone. The German public deficit dropped to 0.6 percent during the first half of the year, the lowest level since early 2008, Destatis, the federal office of statistics, said." Many expect the country's deficit to drop further still.
This piece suggests that the ECB is only likely to intervene, "when the core is really affected in growth or if French spreads continue to widen. If French spreads over bunds go above 300 basis points then the ECB will act." Although the recent German bond auction may have a small, indirect impact on German growth, French spreads are just 1.51% over bunds at the moment.
Nevertheless, many believe that the ECB will have to intervene at some point. Keith Wade, economist at Schroders says: "Every time we call for more action, the German government is saying that they are not going to do unlimited purchases by the ECB, they don't want to try and create inflation. That's the backstop for Germany and they don't want to go beyond that. But they may face a very difficult situation because unless they go further they may face a situation where the Euro could break up unless they take that action."
Of course, there is then the thorny question of whether it will work. Markets appear to have limitless faith in power of quantitative easing to restore confidence, but here Gavyn Davies argues that it may not be the silver bullet they hope: "The ECB is owned by all of its members in proportion to their share of eurozone GDP…If the ECB board chooses to use its notional capital today by buying Italian bonds at subsidised rates, it is in effect triggering a transfer of resources to Italy, away from other members, most notably Germany. This could emerge in the form of ECB losses which might need to be to be recapitalised by member states after an Italian default. Or it might emerge as a reduced flow of future profits from the ECB to nations like Germany. In any event, there would be an implied transfer of resources from Germany to Italy, which is precisely what the German government has opposed implacably."
This implied transfer of resources may be another reason that Germany is opposing printing money, though its explicit objection has always been the creation of inflation and the moral hazard arguments.
Ultimately, it may be careering towards a Eurozone break-up that will propel Germany to support the ECB printing money. This morning Eurozone leaders offered tighter fiscal governance as a sop to the markets, rather than any hint at quantitative easing. They may find markets unsatisfied.
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