Sovereign credit risk to remain in the spotlight?

By Adam Chester, Senior UK Macroeconomist

The travails of Ireland and, more recently, Greece have turned the spotlight back on the sovereign credit markets.

Since November last year, sovereign credit spreads in Greece have widened sharply amid growing fears that the country’s fiscal problems could precipitate a prolonged economic stagnation or a sovereign default.

It is not only Greece, however, that has been affected. Fears of contagion have pushed the spreads of other countries higher, particularly those perceived to have weak fiscal positions.

In this weekly we look at some of the main measures of sovereign credit risk and assess what they imply for country default in 2010.

For countries which share the same currency, such as members of the Euro-zone, the easiest
way of measuring sovereign credit risk is to assess the cost of each country’s government borrowing
in relation to a benchmark - namely Germany (widely seen as the anchor for inflation expectations).

Perhaps not surprisingly, the under-performance of Greece and Ireland has been marked. With 10-yr German bunds currently yielding 3.1%, the spread indicates that Greece is having to pay over twice as much as Germany for 10-year euro-denominated debt.

While comparisons of sovereign bond spreads provide an accurate assessment of credit risk within the Euro-zone, they cannot be accurately applied to countries that have their own currency.

This is because the prevailing level of short-term interest rates also has a key bearing on the level of government bond yields.

Read more (PDF, 232 kB)

* All charts are sourced to Lloyds TSB Corporate Markets Economic Research, Bloomberg, IMF and Datastream

 


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