Irish bond yields supported by low and falling debt ratio and Budget surplus.

Government bond yields in Europe and the US have risen substantially in response to higher inflation, rising short term interest rates and the prospect of more supply as States boost sending to cushion the economic impact of soaring energy prices. The German 10yr benchmark bond , the nearest we have in the euro area to a risk free or ‘safe’ asset, is currently trading at 2.15% from 0.7% just two months ago, with the rise in yields in other member states generally more pronounced.

Investors appear to like Irish bonds in this environment, as the 10yr benchmark here is currently trading at 2.68%, and as such below France and Finland, despite both having a higher credit rating than Ireland (AA- on S&P) .

One factor is Ireland’s low and falling debt ratio. The recent Budget projected Irish Government debt to fall by €10bn this year to €225bn, which alongside a projected GDP figure of €500bn gives a debt ratio of 45% from 55% in 2021.The net debt estimate for 2022 is lower still, at €190bn (largely reflecting cash balances at the NTMA from previous over-funding) which gives a ratio of only 38%. Gross and net debt debt is projected to be broadly unchanged in 2023 but given the forecast growth in the denominator the respective ratios fall to 41% and 35%.

Ireland is also probably alone in the euro area in projecting a budget surplus this year and next. In 2023 the Exchequer surplus is forecast at €1.7bn, which alongside scheduled debt repayment of €9bn implies the need for very limited bond issuance. The euro system owned €73bn of the €156bn bonds at issue at end- September, so the ‘free float’ that can be sold is low.

This relatively low yield on Irish debt also comes after the 2023 Budget with its headlines of an €11bn tax and spending ‘package’, although the presentation can cloud what the Budget actually delivered. Fortunately the Government produces a ‘White Paper’ ahead of Budget day, setting out fiscal estimates for the current and coming year pre-Budget, so allowing a simple comparison with the post-Budget projections.

For 2022 the pre-Budget estimate was for an end-year Exchequer surplus of €5.9bn, against a post-Budget figure of just €345m, a big difference, reflecting the ‘cost of living’ supports of €4.1bn and a €2bn injection into the National Reserve Fund ( the latter is a cash flow out of the Exchequer and so reduces the potential Exchequer surplus but has no effect on the General Government balance). The package also included €0.6bn from money ‘saved’ from the original 2022 budget estimates. So over 40% of the announced measures in Budget 2023 were actually one-off measures for this year.

Turning to next year, the White Paper had forecast a pre-Budget Exchequer surplus of just under €10bn, which post-Budget had fallen to €1.7bn, again a big change due to decisions taken on the day by the Minister for Finance. One was to allocate €4bn to the Reserve Fund, then to increase spending and to cut taxes, with tax revenue €1bn lower largely due to income tax changes. Note though that net current spending is unchanged relative to 2022, as the latter included a €10bn contingency, largely for Covid support, and this falls to €4.4bn in 2023, including a €2bn Ukrainian contingency , so broadly offsetting the increase in ‘core’ spending. Tax revenue is forecast to rise by €5.4bn or 6.6% so the current budget surplus rises to a projected €18bn from €13bn in 2022.

Its also worth noting that the Government seems to share the market’s belief that Ireland’s fiscal position is not a big issue, given the decision to inject €6bn into the Reserve Fund , as debt would have been €6bn lower absent that decision, What constitutes a ‘rainy day’, which would trigger the use of the Fund, remains to be seen.