TheChek News Flow

Gap between the countries’ borrowing costs narrows while investors position for interest rate cuts

A rally in Italian government bonds has narrowed the closely watched gap between the country’s borrowing costs and Germany’s to the lowest level in more than two years, as investors become increasingly optimistic about the prospects for Italy’s economy and position for interest rate cuts.

The so-called spread, or gap, between 10-year borrowing costs in Italy and Germany sank to 1.16 percentage points on Thursday, its lowest level since November 2021, before rising back to 1.23 percentage points. That marks a major turnaround from a level of more than 2 percentage points as recently as October, reflecting growing market confidence in Prime Minister Giorgia Meloni’s handling of the economy, at a time when growth in Germany has stalled.

“Three or four months ago, few could imagine that the spread today, in mid-March, could be 123 basis points,” Italian finance minister Giancarlo Giorgetti told the Financial Times ahead of Thursday’s moves.

He added that he hoped the gap in borrowing costs — known locally as “lo spread” — would “continue in this direction” to 110 basis points as Rome tried to shrink its budget deficit and easing interest rates helped lower debt servicing costs.

The sharp fall in the spread defies many commentators’ early fears that the election of Meloni’s rightwing bloc in September 2022 would unleash a populist spending splurge and put strain on Italy’s relationship with the EU. However, Meloni has defied those expectations, as her government has pursued a path of fiscal rectitude and forged a strong working relationship with Brussels.

Concerns resurfaced last autumn when the government said it would not bring the country’s budget deficit below the limit set by the EU until 2026.

However, since then Italy’s economy has performed relatively well while the outlook for Germany has darkened and Chancellor Olaf Scholz’s government has lurched from crisis to crisis. 

The tightening of the spread also reflects investors’ hunger for high yielding assets ahead of expected European Central Bank rate cuts this summer, as well as the relative resilience of the Italian economy.

Benchmark German government bond yields have risen from 2.03 per cent to 2.42 per cent since the start of January. The equivalent Italian borrowing costs are 3.67 per cent, having started the year at 3.7 per cent. Yields move inversely to prices. 

The Italian public has been familiar with “lo spread” since the eurozone debt crisis more than a decade ago, when worries about Rome’s debt sustainability or a potential exit from the currency bloc caused the gap to widen dramatically to more than 5 percentage points at its peak in 2011.

The falling risk premium on Italy’s debt this year is welcome news for Meloni. In recent days, she has visibly revelled in the success of recent Italian bond issues and the narrowing spreads, which she declared was a reflection of “perceptions of the solidity of the economy”.

Italy’s economy grew in the final quarter of last year while Germany’s contracted. This unusual outperformance could continue, with the Bank of Italy forecasting 0.6 per cent growth this year, while the Bundesbank only expects 0.4 per cent for Germany. 

“Italy hasn’t changed for the better or the worse, but Germany all of a sudden has become a risky country,” said Francesco Giavazzi, who served as economic adviser to former prime minister Mario Draghi. “Markets are starting to get a bit worried.”

The performance of Italy’s bonds comes in spite of its huge debt pile, which rating agency Fitch forecasts will edge higher to 140.6 per cent of gross domestic product this year. In contrast, Germany’s will drop to 64.1 per cent, the agency forecasts.

Italy also has a heavy issuance programme to help service its debt, with interest costs set to rise above 9 per cent of government revenues this year, the agency forecasts. Even though Italy’s budget deficit is forecast by UniCredit to shrink to 4.6 per cent this year, that is still much higher than the 2 per cent forecast for Germany.

“It’s true that Italy is doing better than Germany growth wise and that is unusual,” said Tomasz Wieladek, chief European economist at T Rowe Price. “Better macroeconomic conditions are dominating worse fiscal fundamentals.”

The speed of the narrowing of the spread has taken many investors by surprise. Some attribute it to appetite for higher yielding assets as the European Central Bank gets ready to begin cutting interest rates.

“People have been quite taken aback over the past two weeks, the spread crossed 1.5 percentage points and since then it’s just been in freefall,” said Lyn Graham-Taylor, a senior rates strategist at Rabobank. There has been an attitude among many investors to “go long unless definitively told otherwise and enjoy the carry [higher yields]”, he said.

Italian bonds have been buoyed by a flood of money from retail investors. Meloni has emphasised the importance of retail ownership of Italian debt, and the country’s ‘BTP Valore’ bonds, which are sold exclusively to individuals and provide a bonus to those who buy them at issue and hold until maturity, have raised €53.7bn since June across three tranches.

“It’s a very important element for us, that I am not hiding from you, that our goal is to put the greatest possible part of Italian debt in Italian hands,” said Meloni at a function on Tuesday. “The more you are the master of your debt, the more you are the master of your destiny.”

Blocking cargo ships’ passage through the Red Sea hasn’t noticeably hurt global growth or pushed up inflation

Time was when the bottlenecks in global trade were limited in number and obvious to all. In 1904, the British Royal Navy admiral Sir John Fisher declared: “Five keys lock up the world! Singapore, the Cape, Alexandria, Gibraltar, Dover. These five keys belong to England.”

You can see his point, though it didn’t last. Britain’s loss of control in 1956 over the Suez Canal, for which Alexandria had been the main local port, served as a marker for the end of its empire.

In today’s more flexible trading system, it’s striking how global goods commerce finds a way round even if one of those doors is locked. These days the real chokepoints of globalisation are more varied in function and location, from the ocean floor to space orbit, and their resilience more uncertain.

It’s now three months since the Houthi militants started bombing cargo ships in the Red Sea in earnest. It’s too early to say the attacks are already slipping into a new normal, but certainly there’s no obvious end to them. Yet, although there has been significant disruption to the shipping industry, it’s not been enough to derail global economic growth nor prevent worldwide disinflation.

There’s a nice story, for example, in the difficulties tea, coffee and cocoa currently have in getting to Europe. But this matters a lot more to producers at the start of the journey than to consumers at the end of it. Those three commodities together make up a minuscule 0.26 per cent of the UK’s consumer price basket, and annual British food and drink inflation dropped to 7 per cent in January, its lowest rate since April 2022.

Freight rates have already started falling back from their recent spikes, which peaked well short of the levels they reached during the Covid pandemic. Container ships have been diverted round the Cape of Good Hope, at extra cost and journey times, but there hasn’t been a big reduction in overall freight volumes.

Supply-chain pressures, according to the New York Federal Reserve’s measure, are at historically moderate levels. The trade indicator produced by the Kiel Institute think-tank showed freight rates for cargo to Europe and the volume of goods arriving at North Sea ports stabilising in February. Nature, or at least the global goods industry, is healing.

Nor is there a sense of big shifts in long-run patterns of trade or production. One of the big stories in globalisation at the moment is China’s competitive advantage in exporting electric vehicles, the first waves of which are breaking on the shores of the EU economy. The BYD Explorer No 1, the cargo ship containing the first big consignment of EVs from the eponymous Chinese manufacturer, lost 10 days by having to divert round the Cape but still arrived in Bremerhaven two weeks ago with its 5,000 cars safely aboard.

Certainly, if the situation persists there will be some reconfiguration of supply chains. Some production, particularly of bulky or lower-tech items, may shift from Asia to Turkey or central and eastern Europe to supply the EU market. But many of the fundamental advantages of cost and productivity will endure. Car manufacturing in Europe is not about to get a substantial reprieve from Chinese competition even if Suez shuts indefinitely. 

Multinational companies live or die on their ability to assess risk. They had a test run of the Suez Canal being blocked when the Ever Given container ship got stuck there for a week in 2021. It’s not surprising that the shipping industry and international traders have learnt to absorb shocks without noticeable effects on world trade and inflation.

But while the Houthi attacks may be coming close to a known known, there are also plenty of known unknowns — commercial chokepoints involving technology at which Admiral Fisher would have boggled. Undersea data cables, electricity interconnectors and gas and power pipelines, air transport corridors and hub airports, GPS space satellites: damage to any of these might seriously hamper the communication on which globalisation depends. 

The probabilities of damage here are unclear. We’re in the realm of uncertainty rather than risk. Still, some of those systems have endured repeated damage without catastrophe. Undersea cables are routinely broken by accident (or, on one occasion, pulled up by Vietnamese fishermen looking for scrap metal), but data is automatically switched to others. There are rivals, or at least supplements, to GPS such as the EU’s Galileo. Air cargo has survived pilot and air traffic control strikes and an Icelandic ash cloud that closed north Atlantic airspace in 2010.

Short of systemic challenges such as climate change and major global conflict, the global economy has proved remarkably resilient in the face of shocks. If the Houthis were expecting to hold globalisation to ransom through their Red Sea attacks, they’re failing. There are few indispensable keys to the corridors of global trade, and control of the Suez Canal does not appear to be one of them.

Preliminary investigation initiated into Bavarian developments by collapsed luxury property group

Munich’s state prosecutor is looking into allegations of money laundering at the Signa Group, René Benko’s collapsed luxury property empire.

A spokesperson for the prosecutor confirmed to the Financial Times on Thursday that preliminary investigatory proceedings had been initiated.

Several criminal complaints about activities at Signa companies have been received “since the end of last year”, they said. “The facts of the case are being examined in detail from a legal perspective, also with regard to other possible criminal offences.”

The prosecutor’s exact jurisdiction is still being clarified, the spokesperson added.

The investigation is probing property developments by Signa in Bavaria, a person familiar with the matter said, and the way in which large sums of money were transferred in relation to the developments. Signa’s main holding companies are all domiciled in Austria. It is unclear whether any of them may also be part of the scope of the Munich investigation.

News of the investigation was first reported by the Austrian Press Agency and Germany’s Bild am Sonntag.

The FT reported on Tuesday how creditors to one arm of the Signa conglomerate — which has fractured into several competing bankruptcy estates since its collapse late last year — believe hundreds of millions of euros were misappropriated from the company.

“We have not been informed of any investigations by the Munich public prosecutor’s office,” Benko’s lawyer said, pointing out that his client’s name had not been mentioned by authorities in connection with any potential proceedings against Signa or related entities.

Benko intends to fully co-operate with authorities to help with any investigations should they get in touch, he said.

At its height, Signa sat atop a sprawling empire of luxury buildings and addresses in Europe and America including New York’s Chrysler Building, London’s Selfridges and Berlin’s KaDeWe.

Behind its glamorous showcase of addresses, however, stood a highly leveraged network of more than 1,000 corporate entities, run by Benko and a small loyal team from the company’s headquarters in the alpine city of Innsbruck.

As interest rates rose in the US and Europe in 2022 and 2023, Signa’s financial strength was sapped. Benko has spent much of the past 18 months racing to try and plug widening financial holes in his businesses.

Benko — a paper billionaire by his early thirties, whose rapid ascent to wealth propelled him to celebrity status in central Europe, with politicians regularly gracing his lavish parties — declared himself personally insolvent last week.

It is unclear how much money remains in his opaque family trusts, however, which are held in his mother’s name in Austria and Liechtenstein.

Analysts at JPMorgan last year estimated that Signa owes more than €13bn of debt, but the total could be considerably higher given the array of different instruments and relationships Benko used to leverage the group. Creditors to the group’s main holding companies were this week told they could expect to recoup a third or less of what they are owed over the next few years.

Among the high-profile victims is Switzerland’s Julius Baer. The private bank’s chief executive, Philipp Rickenbacher, was pushed out at the end of January after the lender wrote off the entirety of a poorly collateralised SFr606mn ($689mn) trio of loans it had extended to Signa.

Several civil and criminal complaints against Signa have been filed by aggrieved investors.

Last month a large group of creditors alleged criminal behaviour at the company in a complaint to Austria’s anti-fraud prosecutor. The Austrian prosecutor has yet to state whether it intends to open a case.

Potentially exempt transfers fail leading to hefty bills

More than 13,000 wealthy families faced surprise tax bills as high as £1.4mn on lifetime gifts, after the donor died within seven years of making the bequest, data has shown.

The donors had tried to make use of a rule that allows individuals to make gifts of unlimited value free of inheritance tax if the person survives a further seven years. These are known as “potentially exempt transfers” (PETs).

However, a freedom of information request to HM Revenue & Customs found that in the 2020-21 tax year — the latest for which data is available — 13,380 such PETs failed, and the estate had been charged inheritance tax on the gift, as the donor had died within the seven-year period.

Carla Morris, financial planner at wealth manager RBC Brewin Dolphin, which made the FOI request, said: “Inheritance tax is paid by a few but feared by all. Many people resent having to pay tax on income that has already been taxed, especially at a time when they are grieving.”

She had been surprised by the large number of failed transfers, adding that more of her family clients were wanting to pass wealth to younger generations during life rather than on death.

These individuals should start thinking about their estate and financial planning sooner rather than later to ensure the maximum inheritance for beneficiaries, she said. “Leave it until your 80s, and the risk becomes far greater that you won’t survive the full seven years.”

Morris also highlighted the large amount of tax some failed gifts had attracted. According to the FOI data, the top 50 failed gifts averaged £3.6mn after allowances and exemptions, which Morris calculated would trigger an “eye-watering” bill of up to £1.45mn if the PET failed within the first three years.

Inheritance tax is charged at a rate of 40 per cent on the value of an individual’s estate above £325,000, if they die within three years.

If the person making the gift dies after three years, the inheritance tax rate falls to 32 per cent on the value of the gift above the £325,000 threshold. This drops to 24 per cent for gifts made between four to five years before death; to 16 per cent for gifts made between five and six years before death; and falls to 8 per cent for those who die within six to seven years after the gift.

The average failed gift was worth £156,000 after allowances and exemptions, the FOI showed, resulting in a tax bill of £62,400 if the PET had failed in the first three years.

Inheritance tax is regularly selected as the “most unfair” tax in opinion surveys, although in the UK it is paid by a small proportion of estates — less than 4 per cent.

Nevertheless, the number of estates faced with an inheritance tax bill has been increasing in recent years, jumping by 17 per cent to 27,000 in 2020-21. Britons owed a record £5.76bn in inheritance tax in 2020-21. This was driven by increased mortality during the pandemic and a freezing of the threshold at which inheritance tax applies. The threshold of £325,000 has not been increased since 2009.

While there had been reports the government had been considering scrapping inheritance tax or reducing its rate, these failed to materialise in last week’s Budget.

A government spokesperson said: “More than 93 per cent of estates are forecast to have zero inheritance tax liability in the coming years — however, the tax is forecast to raise almost £10bn a year by 2028-29 to help fund public services millions of us rely on daily.

“Estates of surviving spouses and civil partners can pass on up to £1mn without an inheritance tax liability — significantly more than the average UK house price of £285,000.”

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