Worst of debt crisis ‘may be over’

The worst phase of the eurozone debt crisis could be over, as contagion from the worst-affected countries such as Greece is no longer having a systemic impact on the region, according to a new report by the Central Bank.

Markets are once again pricing sovereign bonds, according to country specific circumstances.

The report’s authors, Thomas Conefrey and David Cronin, looked at sovereign bond spreads throughout the eurozone from the advent of monetary union in 1999 to now.

The early years of the euro triggered a huge contraction in bond yields, as there was a positive contagion effect from the core to the periphery countries.

In other words, in the years leading up to the financial crisis, countries on the periphery such as Greece, Portugal and Ireland, which traditionally had higher borrowing costs than France and Germany, could now borrow at much lower rates.

Consequently, there was a massive build up of public sector debt in Greece and private sector debt in Ireland. Moreover, this trend of a positive feedback loop from core to periphery held up in the first phase of the crisis from March to Oct 2008.

“This might be unsurprising in less turbulent times and when country- specific issues were not as important, as has been described by commentators on the early stages of the financial crisis,” the report said.

But after Oct 2008, country-specific issues started to have a huge impact on the debt crisis.

The decision by Ireland to backstop the contingent liabilities obviously put huge strain on the sovereign. Moreover, in Greece, it emerged that the true level of debt was much worse than had been officially flagged.

The relationship between core and periphery reversed. At the time of the first Greek bailout in May 2010, there was a massive spillover for other eurozone members.

The report finds the securities markets programme launched by the ECB to stem the worst effects of the crisis had little effect on bond yields. The second bailout of Greece had much more of an effect in decoupling Greece from the wider eurozone.

“The results suggest that the influence of peripheral member states, in particular, Greece, on the euro area sovereign bond market has diminished, at least for the moment, and that pre-crisis interaction patterns appear to be reoccurring after a period of extreme stress.

“If this reflects a greater focus by financial markets on country-specific issues, it is a development that should be broadly welcomed.”