Bond selloff means record-high debt financing costs for Ireland, Portugal; German T-bills soar

DUBLIN (AP) — Investors sold off Irish and Portuguese bonds Thursday, driving the borrowing costs of both countries to euro-era records and reinforcing worries about the heavy debts some European governments are carrying.

Analysts say Ireland, in particular, faces a high-pressure few weeks ahead as its government must convince international investors that it won't have to tap an emergency EU-IMF fund — and won't keep sinking billions more into its most debt-crippled bank.

Worries over Ireland's ability to fund its own debts and those of five state-insured banks have driven the interest rates on Irish bonds to a series of record highs dating back to the 1999 launch of the euro. Rates on existing bonds rise when they're being dumped by investors, because yields increase as prices fall.

If risk perception remains high, paying those higher rates is the only way to attract new buyers when governments need to borrow again.

Two years ago, before Ireland's long-booming economy went into freefall amid a burst property bubble, its bond interest rates were nearly identical to those of Germany, the benchmark of safety in the 16-nation euro zone.

But those days of viewing the Irish as financially secure as the Germans are long gone. Investors today demand increasingly higher Irish rates as compensation for their belief that the Irish are among the most likely in Europe to fail to pay them back. Greece is top of that list, the Portuguese in third place.

The gap between the payouts for German and Irish 10-year bonds surpassed 4.25 percent Thursday for the first time, the latest in a series of such records. The Irish treasuries were offering yields of 6.54 percent late Thursday, up 0.2 points on the day, compared to just 2.285 percent for the German notes.

Conversely, the payout on Germany's flagship bonds fell sharply Thursday after the German government surprised investors by announcing much better-than-expected tax collections and plans to slash its borrowing plans by nearly euro30 billion in the final quarter of 2010. That made German bonds an even more attractive safe haven.

Ireland insists there's no chance it will seek international aid, noting that its bond sales have secured government funding through mid-2011, so there's no need.

But Finance Minister Brian Lenihan is hedging his bets on whether he will allow partial defaults on loans owed by nationalized Anglo Irish Bank.

The government has received European Union approval to extend blanket state insurance to Irish-owned banks through the end of the year. But Lenihan has yet to confirm whether the government will actually do this for Anglo Irish, Europe's biggest financial sinkhole.

Anglo gambled heavily on galloping property markets in Ireland, Britain and the United States — and now faces loan writeoffs estimated to exceed euro35 billion, a fifth of Ireland's shrinking GDP. Most of the money it loaned came from foreign bond holders, who are guaranteed a full repayment under terms of Ireland's about-to-expire state insurance.

Irish media are speculating that Lenihan will opt not to keep offering a guaranteed repayment to Anglo's lowest tier of "subordinated" bondholders, who if fully insured against losses would represent a euro1.7 billion bill for Irish taxpayers.

Until the outside world is convinced that Ireland has got its deficit and bank-bailout costs capped and turned around, analysts say the Irish will keep paying over the odds.

Ironically, if the Irish gave up and turned to help from the EU-IMF emergency fund established earlier this year to bail out the Greeks, they would be able to borrow at a rate of 5 percent. Instead, earlier this week Ireland drummed up euro1 billion in an auction of 8-year bonds that, to be sold, required a rate of more than 6 percent.

Portugal faces similarly tough choices. It's just beginning the process of slashing its spending to get a deficit under control, and its latest bond issues this week also commanded punitive premiums: A euro750 million auction of new 4-year and 10-year bonds paid out yields of 4.69 percent and 6.24 percent, respectively.

On Thursday Portugal's 10-year bonds were offering yields 4.08 percentage points above their German counterparts, another euro-era record.

In Berlin, the European Union's financial and monetary affairs commissioner, Olli Rehn, told a conference he didn't envisage that any debt-crippled member of the 16-nation euro zone would default on loans.

"The potential costs, both economic and political costs, of this for the euro zone and the European Union would be so devastating that we will do everything to avoid it. And I'm certain we will be able to avoid it," said Rehn, who didn't comment on whether the Irish should, or would, seek an EU-IMF loan. He previously has discounted such a move as unnecessary given Ireland's commitment to emergency budgets and deficit-cutting through 2014.

Ireland also confirmed Thursday it remains mired in recession, further depressing sentiment for its loan-repayment prospects. Its second-quarter GDP figure slid 1.2 percent versus the previous quarter, surprising economists who had expected a 0.5 percent increase.

Greece, which is rebuilding its finances with euro110 billion in help from the EU-IMF fund, says international bond speculators are unfairly punishing the weakest euro-zone members. Greek debt is rated the world's riskiest; its 10-year bonds are paying a giant 9-percentage point interest premium above German treasuries.

Greek Finance Minister George Papaconstantinou said his country's bonds ought to be requiring lower interest rates than before the EU-IMF bailout, but instead were higher.

"It's clear that risk was underpriced then, but it's massively overpriced now," he said.