Eurozone government borrowing costs reached their highest level in over a decade due to concerns over elevated Italian and French budget deficit forecasts and expectations of prolonged higher interest rates. The spread between Italian and German bond yields, a measure of market risks in the euro area, hit its widest level since the US banking crisis in March. Italy’s 10-year yield also rose to its highest level since 2013, while France’s 10-year bond yield reached its highest since 2011. The bond market sell-off further intensified as central banks signaled that borrowing costs would remain high to tackle inflation before considering rate cuts.
The surge in borrowing costs was accompanied by a €3bn sale of 10-year bonds by the Italian treasury, which offered investors a 4.93% yield, the highest since 2012. Italy’s government revised this year’s fiscal deficit projection to 5.3% of GDP, up from the previous target of 4.5% due to the soaring cost of a controversial tax credit scheme for home improvements. Next year’s deficit target was also increased to 4.3% of GDP, allowing the government to prioritize policies such as aiding low-income families and incentivizing population growth. The widening spreads between Italian and German bonds were attributed to the unexpected increase in Italian deficit projections, which would result in a larger supply of bonds for the market to absorb.
Concerns about persistent inflation and tight monetary policy were further exacerbated by surging oil prices, which reached a 10-month high of over $97 a barrel. The combination of market moves and heightened risks led to growing fears of a recession and financial crisis. The bond market was described as being “caught in a perfect storm,” as investors faced wrong positioning, revisions to budget deficits, and elevated inflation expectations.