Brexit fears hit demand for Irish Government debt

The extra interest that investors demand to buy Irish Government debt over German bonds has widened to a 5½-month high as worries over the economic impact of a possible messy Brexit hurt demand.

UK prime minister Theresa May last week disclosed a draft agreement on leaving the European Union that met with strong opposition from within her party, and which could spark a confidence vote in her leadership and increase the chances of a "no deal" Brexit.

The UK is one of Ireland’s biggest trading partners, and the Border between Northern Ireland and the Republic is a key issue in Brexit talks.

"A no-deal Brexit could have an adverse impact on Ireland's economic picture, which would impact risk assets and have some effect on government bonds as well," said Commerzbank rates strategist Rainer Guntermann.

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“It could affect the country in general, it could impact the budget position, the deficit position, and generally weigh on risk assets as well.”

Printing money

While government bonds are generally not considered risky assets, euro zone government debt – especially lower-rated debt – often tends to perform differently, since individual countries don’t have control over printing money.

So while British gilt yields dropped on the reaction to the contentious Brexit proposal, Irish yields increased, with 10-year yields hitting a one-month high of 1.045 per cent on Friday.

The spread between Irish and German 10-year bonds hit a 5½-month high of 65.5 basis points after the official close on Friday, and early on Monday stood at 62 basis points.

German bonds have been the subject of flight-to-safety demand, increasing many spreads across the euro zone, but Ireland’s underperformance stands out.

Closest peer

For example, the Irish 10-year bond yield’s spread over its closest peer, Belgium, also reached its widest level since late May on Friday at 23.5 basis points, and was at 21 basis points in early trade on Monday.

Elsewhere, Italian government bond yields dropped 3-5 basis points across the curve, with analysts pointing to some conciliatory comments from 5-Star Movement leader Luigi Di Maio as a potential driver as budget talks between Italy and the EU proceed.

Di Maio reiterated over the weekend that the government was willing to sell real estate assets, reduce waste and introduce safeguard clauses to ensure the deficit will not exceed the target of 2.4 per cent of output in 2019. But he said: “The main reforms of the budget must remain in place.”

The yield on Italy’s 10-year government bond was down 5.5 basis points at 3.44 per cent, while the spread over Germany tightened seven basis points to 305 basis points.

The improved risk sentiment saw the yields of higher-rated bonds rise, with German 10-year yields, the benchmark for the region, 1.5 basis points higher at 0.385 per cent. – Reuters