The past weeks have been full of political events that have shocked our every-day life (and sometimes our mental health, too). Politics is deeply linked to financial markets, and it was no surprise that the Italian “game of government” had significant effects on the economic scenario. During the last few days the word “spread” has returned in the vocabulary of Italians, but what is it? How does it affect our lives?
The term “spread” is used to address the difference between the yields of two financial instruments with similar characteristics. In this specific case, we are considering the difference between the interests of Italian government bonds (BTPs) and German government bonds (BUNDs) with 10 years-maturity. This difference has reached 300 points, meaning that interests on BTPs were 3,11% while the ones of BUNDs were 0,28%. The higher the yield, the higher the risk, therefore a high spread reflects a situation where Italy is considered a risky investment.
The consequences of a high spread affect families, enterprises and financial institutions. Here we summarize the main effects in 4 points.
1) BOTs and BTPs. Some consequences are immediate, and this is the case for 6 months- Bot issued by the Italian Government: from the last auction interests have increased from -0,41% to 1,213%. Considering that BOTs in circulation have a value of about 110 billion euros, the annual expenditure for the coupons would increase of 1,3 billion euros. Moreover, the rise of interest rates makes it disadvantageous to sell BOTs and BTPs before maturity.
2) Mortgages. A high spread can have consequences on mortgages instalments and, more generally, on the amount of credit given to families and enterprises. For fixed-rate mortgages there will be no changes on the instalments, since they are not calculated using the inter-bank rate as base. For existing variable-rate mortgages, there will be no immediate effects because they are calculated using the EURIBOR, which has been fixed for two years. The EURIBOR is not expected to change, unless the Italian crisis will affect other European countries. Regarding new mortgages the situation is slightly different. Banks hold about 300 billion euros of Government bonds, and if those instruments lose value the income of banks reduces drastically. In order to counteract to the loss of profit, banks will charge customers with higher mortgages instalments.
3) Public debt. As the spread increases the Italian Government has to pay higher coupons on its bonds, thus making the public debt higher.
4) Enterprises. If the spread continues to be high, enterprises will be forced to issue bonds at higher interests and this would drastically increase their cost of capital. Moreover, in such situation it would be difficult to obtain loans by banks.
As we have just seen, the worlds of economics and politics are deeply linked and it is essential to always be aware of what is happening around us.