The European Central Bank will initiate the turnaround in interest rates from July. This will be expensive for all euro countries that have so far relied on short-term bonds. Germany is at the forefront.
Now it has done it after all: Due to the continuing rise in inflation, the European Central Bank (ECB) is also counteracting the high prices with higher interest rates from July. For the time being, the key interest rate is to rise from 0 to 0.25 percent. However, the next rate hike is already on the cards for the fall. Many economists are also calling for even larger hikes given the fact that the inflation rate in the euro zone recently rose to a record 8.1 percent.
Low interest rates have been popular with those who like to borrow in recent years. Not only was the real estate industry booming in this climate, states were also able to borrow very cheaply. Many countries took advantage of this, especially during the Corona crisis. Creditworthy debtors like Germany could even demand negative interest – so they were still being paid for their debts.
With the key interest rate, however, bond interest rates will now also rise again, presumably by the same amount. This does not matter for bonds that have already been issued. The interest rate was agreed here at the time of issue and cannot be changed for the term. However, government bonds expire at some point and then a state has to issue new bonds under the conditions that apply at that time.
In general, the maturities of bonds in all countries are very mixed. Short-term bonds with a remaining term of less than five years make up between 32 percent and 58 percent of the respective bonds in the euro area countries – measured by the volume of the bonds, not their number. In the ECB’s zero-interest phase in recent years, the trend has tended towards states issuing more bonds with longer maturities in order to lock in the favorable interest rates for as long as possible. Austria, for example, even issued 100-year bonds.
Longer-dated bonds have higher interest rates because the risk for bond buyers that a state could go bankrupt by the end of the bond also increases. This is hardly to be expected for bonds over one year. Accordingly, a higher proportion of short-term bonds has the advantage that a state can secure lower interest rates – but is also more susceptible to interest rate increases.
This is particularly the case in Germany. With a share of 58 percent, we have the highest share of short-term bonds in our portfolio. The data is from the end of 2020 because there is no evaluation for the past year. Assuming that the debt structure has not changed since then, the interest rate hike by the ECB will cost us dearly. For this year alone, with two increases of 0.25 percent each in July and October, around two billion euros are due because new bonds with correspondingly higher interest rates have to be issued. For 2023 there are even additional costs of around 2.3 billion euros.
Measured against general government spending, Germany would have the highest extra costs. 4.312 billion euros – albeit spread over a little over a year and a half – make up around 0.85 percent of our state budget for 2020. France and Italy follow in second place, each with additional costs of 0.75 percent of their state budget, ahead of Spain with 0.73 percent. Least affected by the rate hike in the near term is Estonia. At 32 percent, the Balts have the lowest proportion of short-term bonds and thus only have to reckon with additional costs of 5.2 million (!) euros or 0.05 percent of their state budget by the end of 2023.
In absolute figures, however, Germany is not ahead. Both Italy (EUR 4.668 billion) and France (EUR 4.387 billion) pay more, but also have larger national budgets, so that the percentage of interest costs does not carry that much weight.
Important: the figures are only estimates. The data on the debt structures of the euro countries are very incomplete. For example, Finland, Greece, Luxembourg, the Netherlands, Austria and Cyprus do not have complete data even for 2020. They are therefore not included in our calculation. And in the case of the other 13 euro countries, too, it is not possible to say exactly which bonds will expire and at what terms and conditions will be replaced.
For the sake of simplicity, we have assumed that every state has to offer as much more interest for new bonds as the ECB raises the key interest rate. The fact that this will happen by 0.25 percent quarterly by the end of 2023 is just an assumption that does not have to be correct. Larger interest rate hikes would increase the costs, smaller adjustments would lower them.
There is another effect that influences the additional costs for states as a result of the interest rate hike, which the Deutsche Bundesbank had already pointed out last year. The ECB itself now holds a significant share of the government bonds of the euro countries through its bond purchase program. Depending on the country, these have a value of more than 40 percent of the gross domestic product. States pay interest on these bonds to their national central banks. This increases the profits of the central banks, which are distributed to the states at the end of the year – so many states effectively pay part of their interest to themselves.
In addition, the bond purchase program is bringing a lot of fresh money into the economy, but much of it is lying around with commercial banks. They then have to park it overnight at the ECB, for which a negative deposit rate has been charged so far. So the banks pay the ECB to keep money there. That, too, has increased the profits of the central banks and, conversely, government revenue.
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Parallel to the increases in the key interest rate, however, the bond purchase program will now also be ended and the deposit interest rate will be lifted out of negative territory by October at the latest. This means that two sources of income for the ECB and the national central banks are gone – and, conversely, important funds for the euro states as well. It’s not about peanuts: France received around 6.6 billion euros in this way in 2020. In Italy it was 4.6 billion euros, in Spain 2.2 billion euros. The Deutsche Bundesbank had built up reserves in 2020 because of the corona crisis instead of distributing profits. The year before, she had transferred 5.9 billion euros to the federal government.
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