Bond Markets Want Clarity on EU Deficits, ESM Economist Says

William Horobin
·3 min read

(Bloomberg) -- European Union governments must resolve divisions over new deficit and debt rules to give clarity to bond markets on how they will repair public finances after the Covid pandemic and energy crisis, European Stability Mechanism Chief Economist Rolf Strauch said.

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Limits designed to avoid runaway borrowing have been suspended since 2020 to allow support for households and businesses. EU capitals are still at loggerheads as they scramble to agree a revamp before the old pact is reinstated on Jan. 1.

“We have a lot of market contact and we clearly see that investors are interested in having a clear picture of fiscal policies,” Strauch said in an interview with Bloomberg. “It would be very helpful in terms of forward guidance to have the new framework in place.”

The ESM was created in 2012 with a mission to avoid a repeat of the euro-zone crisis by acting as a lender of last resort when governments lose market access.

Its chief economist’s comments on the need for fiscal rules come after wariness over sustained high interest rates fueled a global selloff in government bonds this week that brought long-term borrowing costs in the US and Europe to the highest levels in more than a decade.

While EU governments don’t risk a vacuum without a new deal, Strauch said the Stability and Growth Pact as it stands has proved problematic.

“The experience of the existing fiscal rules has been only partially positive in the sense that the implementation has been sometimes lacking — there are some elements that need to be improved in terms of transparency,” he said.

With interest rates set to be higher for some time as the European Central Bank maintains tight monetary policy, Strauch said governments need to stick to commitments to a more restrictive fiscal stance. They can no longer rely on rising output to offset greater borrowing, according to the economist.

“If there’s one lesson to be learned at this stage it’s that it’s not advisable to believe that a favorable relationship between growth and interest rates would allow you to run fiscal policy with high debt levels,” Strauch said. “Governments have to count on the fact that interest rates will be above growth.”

Mitigating Risks

Still, he said vast public spending in recent years has built up cushions for households and companies that will mitigate risks as the ECB’s interest rate hikes feed through to the economy. There are still idiosyncratic risks to monitor, he said, but overall corporate debt burdens are manageable, and stress tests show banks could weather a severe downturn.

“The question that always matters for the ESM is whether we have the resilience to also avoid a more systemic financial stability crisis,” Strauch said. “The clear point is that we have that resilience because we still see some buffers in the system that will allow it to handle that situation.”

--With assistance from Zoe Schneeweiss.

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