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Can there be a sovereign debt crisis in the Eurozone? This is what Nomura says.

Can there be a sovereign debt crisis in the Eurozone? This is what Nomura says.

“For now, sovereign default risk appears to be low thanks to inflation keeping nominal growth rates high and pass-through from the ECB’s higher rates to government borrowing costs has been minimal so far. We consider how the risk climate might change as these effects reverse, as we anticipate will,” the Nomura report states.

“If countries want to get down on the path of debt sustainability, several will have to make big adjustments to their fiscal balances. However, other countries have more fiscal space and can afford to spend more if necessary. In general, countries have taken advantage of QE years and low interest rates to restructure their debt and hedge against rising interest rates.

“Sovereign stress risk may be overvalued by the market and therefore BTP-Bund spreads may continue to narrow, as they have already done in recent months,” they add at the bank.

As Nomura explains in his report, debt becomes unsustainable when investors no longer believe that a government can pay it back. It’s not just the current level of debt that’s important, but also the government’s plan to pay it off. The viability of such a plan depends on the trajectory of growth, inflation, interest rates, and fiscal policy. If these variables become incompatible with stable long-term debt, investors will doubt a government’s ability to repay its debt and sovereign default risks may increase.

“The current situation of the euro area economies seems less problematic. Most economies are in the bottom two quadrants. The risk of a ‘snowball effect’ is very low because the Euro area inflation It is currently high (8.5% in January), which keeps the euro area’s nominal growth rate at an average of 6.7% for the fourth quarter of 2022.

Although the ECB increases the Interest rates, debt servicing costs remain low for now and it will take a long time for higher central bank rates to translate into higher borrowing costs. The average nominal yield on outstanding euro area debt was only 1.6% in the third quarter of 2022 and compares with 3.6% in the fourth quarter of 2009.

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