EC fiscal policy announcements affect sovereign bond value, say EconPol researchers

European Commission macroeconomic, fiscal and monetary policy announcements have a direct impact on the value of sovereign bond spreads, according to new research from EconPol Europe.

Using data from 10 European Monetary Union (EMU) countries from January 1999 to July 2016, economists António Afonso, João Tovar Jalles and Mina Kazemi found that EC releases of the excessive deficit procedure significantly affected yield spreads. Forecasts of higher debt and better budget balance contributed to the rise and the decline of spreads, while announcements of the European Central Bank’s key interest rates, together with the longer-term refinancing operations and the first covered bond purchase programme, negatively affected sovereign yield spreads.

The research finds that the announcement of a negative fiscal forecast by the EC, for example an upward revision in the public-to-GDP ratio, contributed to the increase in bond spreads. A positive fiscal announcement, such as a downward revision in the public-to-GDP ratio, contributed to the decrease in spreads.

The researchers also found that noncomplying with the Excessive Deficit Procedure increases sovereign yield spreads, suggesting that investors associate higher risk of default to the bonds of countries that are not characterized by positive economic prospects.

The paper modelled spreads on a fixed block of determinants that deal with international risk conditions, liquidity risk, credit risk and economic growth. Four different types of fiscal and monetary event variables were added: EC releases of the short-term economic forecasts, excessive deficit procedures, announcements of the ECB’s main interest and unconventional monetary policies.