ANALYSIS:While the sovereign debt issue disproved the market's worst fears, far more clarity is needed

AS MARKET tensions rose ahead of Tuesday’s much-anticipated sovereign debt issue, the Irish once again became the bête noire of global markets, with investment bank Citigroup dubbing Ireland “the new Greece”, and the Financial Times declaring that “investors have turned against Ireland”.

Central Bank governor Patrick Honohan attempted to downplay poor market sentiment by describing Irish borrowing costs as “ridiculous” and the bailout of Anglo Irish Bank as “manageable”. But, while the success of Tuesday’s auction may give short-term relief to the markets, the bigger question remains: where can Ireland go from here?

In events reminiscent of those of last May, when the so-called “wolf pack” attacked peripheral European sovereign debt markets before the European Central Bank came to the rescue with a €750 billion bailout, panic hit the debt markets last week when the Government revealed the cost of bailing out Anglo was going to be higher than expected, at €24 billion. Although the cost of recapitalising Anglo will be funded over 10-15 years – at €2.5 billion a year – it nonetheless raises the prospect of pushing up this year’s deficit to GDP (gross domestic product) ratio to a staggering 25 per cent.

Market jitters sent the spread, the difference in yield between Irish and German bonds, soaring, pushing up considerably the cost of funding for the Government.

In normal circumstances, it could be expected for the spread between Irish and German bonds to hover at about 50-100 basis points. In 2008, the average spread was just 50 basis points, rising to 188 last year. For this year, spreads have averaged at 205, peaking at 305 last May. When the market got scared ahead of this week’s auction, the difference rose to 300 basis points. Spreads have since come down to about 290 basis points.

Irish sovereign credit default swaps, a type of insurance against the risk of default, also spiked, soaring to more than 300 basis points, and pushing the cost of insuring $10 million (€7.7 million) of Irish debt up to $300,000, from $200,000 a few weeks previously.

While the uncertainty over the Irish banking sector bailout rattled investors’ nerves, some market players laid the blame for the volatility on expectations of a wave of new bond issues from European countries and banks in September and October, and on low liquidity levels for Irish bonds.

“In a quiet August, Ireland became the focus of attention,” says Anthony Linehan, deputy director of funding and debt management with the National Treasury Management Agency.

Ciaran Callaghan, a banking analyst with NCB Stockbrokers, agrees. “With very little news flow it was blown out of proportion,” he says.

But regardless of the validity or otherwise of fears, the reality is that Ireland’s reputation was damaged among international investors by the volatility.

While Greece may be out on its own, with the difference in yield between its 10-year sovereign bonds and Germany’s at more than 800 basis points, the events of last week mean Ireland is next in line in terms of the “stress periphery”, followed by Portugal, with spreads of some 280 basis points.

But Padhraic Garvey, a fixed-income strategist at ING Group in Amsterdam, says what happened to Greece is not on the agenda for Ireland. “There is no sense in the market that Ireland could be compared to Greece,” he says, although he adds that a combination of downgrades, which led investors to flee Greece when it was accorded junk status, and poor Irish Government policy decisions, could spell trouble.

And, while Tuesday’s successful € 1.5 billion bond auction by the National Treasury Management Agency, oversubscribed 3.4 times, may have dampened volatility, it came at a price. “There was a fantastic concession built into the price ahead of the auction,” Garvey says.

Now, analysts say further clarity is needed on how much the recapitalisation of the banking sector is going to cost the Government, given the recent upward revisions in the cost of both Anglo and Irish Nationwide, before spread levels fall. On top of this comes the uncertainty arising from what the Government is going to do about its debt guarantee of the six biggest financial institutions – expiring between September and December.

This lack of clarity was noted on global markets, with investment bank Nomura referring to the €25-€30 billion “funding cliff” facing Irish banks as redemptions kick in in September.

Mr Callaghan says banks will have been preparing to replace this funding. “It depends what they’ve been doing. If they’ve been getting their houses in order then it’s not too serious,” he says, adding that banks have the option of raising money in the markets, or getting liquidity by bringing National Asset Management Agency bonds to the ECB.

The consensus seems to be that unless there is a dramatic improvement in debt markets, the guarantee will extend beyond the end of this year.