"Iran shock" sparks concerns about fiscal deterioration, eurozone borrowing costs soar to multi-year highs

``` Iran tensions drive up energy prices, inflation expectations rise, and eurozone government bonds record one of the most severe monthly sell-offs in nearly a decade. Borrowing costs for countries such as Italy, France, and Spain have been pushed to multi-year highs, while market concerns about governments being forced to increase fiscal spending to protect consumers have intensified simultaneously. Italy’s 10-year bond yield climbed to 4.14% this month, a new high since mid-2024, rising about 0.8 percentage points in the month—comparable to the scale of the sell-off during the previous energy crisis in 2022. France’s 10-year yield reached nearly 3.9% intraday, the highest since 2009; Spain’s yield approached 3.7% for the first time since the end of 2023. The shock from Iran has driven up oil and gas prices and heated up inflation expectations. The European Central Bank may be forced to raise rates three times this year. Meanwhile, national finances are deteriorating due to energy subsidy measures, the bond market sell-off is intensifying, and borrowing costs are spiraling upward. Inflation Shadow Returns, Central Bank Takes Cautious Stance According to the Financial Times, ECB Executive Board member Isabel Schnabel stated on Friday that “the specter of inflation has returned,” with the speed of this shift exceeding the expectations of “many people.” But she also indicated that the ECB does not need to “act hastily” and that there is “time to observe the data,” waiting for further evidence of a second-round inflation effect. ING economist Bert Colijn noted that the current rise in yields partly reflects investors closing previous bets on narrowing yield spreads, especially focused on Italy. He said there is, as yet, no significant market concern about eurozone sovereign debt risk, but “if the situation continues to deteriorate and the cost of fiscal measures rises further, that risk could still emerge.” T Rowe Price’s Chief European Macro Strategist Tomasz Wieladek commented: “Investors are realizing we are entering a phase of low growth and high inflation, combined with more fiscal stimulus and expanding government spending.” Varying Responses by Country In response to the energy price shock, eurozone countries have shown unequal fiscal reactions but are generally facing the dilemma of limited room to maneuver. On Thursday, Spain’s parliament approved a €5 billion tax cut package, reducing VAT on electricity, natural gas, and fuel from 21% to 10%. The plan was proposed by left-wing Prime Minister Pedro Sánchez. Italy temporarily cut fuel consumption tax by 20% until April 7, at a cost of roughly €417 million, after which it will be reassessed. Rome plans to offset tax losses by cutting spending in other areas, including healthcare. France has chosen to hold the fiscal line and has not implemented large-scale energy subsidies. The French Prime Minister, citing a fiscal deficit of 5.1% of GDP by the end of 2025, said “there is no piggy bank to tap.” The government has only introduced targeted measures for sectors heavily hit, such as agriculture and truck transport, with a cost of about €70 million in April. Bruegel institute senior fellow Simone Tagliapietra pointed out that the measures announced so far by countries like Spain indicate “we are talking about significant sums of money.” He warned: “European governments face fiscal constraints and a lot of competing demands, especially for defense spending. Public budget space is very limited. I do not think there is room for large-scale fiscal action as in 2022–2023.” Intensifying Budget Pressure, Smaller Buffer This Time The previous energy crisis serves as a cautionary reference for the current situation. According to Bruegel, since the outbreak of the energy crisis in September 2021, European countries (including the UK and Norway) have allocated and reserved a total of €651 billion to protect consumers from the impact of rising energy prices. The OECD pointed out this week that many measures in the last crisis “lacked targeting and had significant fiscal costs,” warning that measures taken this time to cushion against rising energy prices will “further intensify existing budget pressures for most governments.” Natixis CIB’s Global Research Head Jean-François Robin said investors are betting that public finances across the eurozone “will deteriorate,” as countries are spending “large amounts of public money” to absorb this shock. Reversal of the Spread Advantage, Key Threshold Risks This bond sell-off has already led to a reversal of the spread advantage for highly indebted eurozone members compared to Germany. For example, Italy’s 10-year bond spread versus German bonds, which was about 0.6 percentage points before the conflict, has now returned to nearly 1 percentage point. Investors emphasize that the current spread is still moderate from a historical perspective—Italy’s spread once touched 3 percentage points during the pandemic. Pimco portfolio manager Konstantin Veit stated, “Current spread widening does not negate the logic of long-term convergence,” noting that it would take several years of high rates and low growth to truly spark concerns over debt sustainability. However, some analysts warn of key threshold risks: should the German 10-year yield (currently about 3.1%) surpass 3.5%, Italy and France’s borrowing costs could be pushed towards 5%. T Rowe Price’s Wieladek warns that at that point, “debt sustainability would become uncertain.” Risk Warning and Disclaimer The market carries risks, and investment requires caution. This article does not constitute personal investment advice, nor does it take into account the individual investment objectives, financial situation, or needs of any particular user. Users should consider whether any opinions, views, or conclusions in this article are suitable for their particular circumstances. Any investment based on this is at your own risk. ```