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AB 2000 studies

Alain Boublil Blog

 

Interest rates recovery: don’t panic !

Interest rate on French 10-years bonds reached 1.17% last Friday, its highest level for three years apart from a short period during 2015 spring. The expectation of Federal Reserve decisions, which rose that week its short-term rates by 0.25% and the political uncertainties in France, just before presidential elections, have provoked for three months a slow increase of  borrowing costs, slightly more important than in Germany, which is the reference on these issues. The spread between our two countries, which is usually 30 basis points rose to near to 70 basis points. That trend has provoked a wave of alarmist comments, widely unjustified, which hide what is really at stake.

First, 1.17% is three times less than what the Treasury was paying five years ago and, if we take into account inflation which reached 1,2% during these last twelve months, it is a real interest rate near zero. It is also twice less than the rate paid in 2016 by the State on its whole debt. Since the beginning of the year, due to European central bank policy, short-term financing with a maturity inferior to a year, still carries a negative interest rate, -0.6% as an average. Regarding mid and long-term issuances, also as an average, the cost of borrowing staid by large under 1%. Despite the recent rebound, France still benefits from highly favorable financing terms. This year, the State will have to reimburse two bonds. The first one with an amount of 27 billion euro carries a 3.75% interest rate. The second one with an amount of 33 billion euro carries a 4.25% interest rate. The yearly costs of these two bonds was until now 1.6 billion. In refinancing that debt at current rates, the cost in the future will be around 0.6 billion and the State will save one billion in each future finance bill. This example shows, in concrete terms, the true consequences of the current level of interest rates on public finances.

We have, here in this blog, frequently denounced the practices followed by Agence France Trésor, which manages the State debt. Through the issuances of bonds carrying higher interest rates than the market ones and pocketing premiums, it had reduced the benefits resulting in the future from current interest rate fall. During the last two years, in 2015 and 2016, the total amount of these premiums had reached 45 billion euro. Cour des Comptes last June was upset about that and media started to be interested by this issue in December. The Treasury seems to have understood the message and it has abandoned that practice. France has issued since the beginning of the year about 55 billion euro in bonds, i.e. almost one third of its program for the year 2017. Unlike the two previous years, almost all issuances were proposed with market interest rates and even sometimes inferior to them. That will amplify, in the future, the reduction of public debt cost. Incidentally, the quickness with which this about-turn was done shows well that the issuance policy was not only determined by investors demand.

Contrary to what we hear, the current rate rise will not weight on the debt charge until rates are higher than those of the bonds which are coming at maturity. But these previous rates are still twice or three times higher than current ones. In the worst case, if the rise was going further, that move will only slow the reduction of the annual cost of the interests the Treasury has to pay to the investors. So, it is useless to activate the alarm bell. The State is going to profit, during a long period of time, from current monetary policy decisions, if, of course, France remains in Europe. Corporations will, in that case, reduce their financial charges, situation which curiously generates very few comments.

The others beneficiaries of this policy are households. Building activity rebound ssince last year is the result of better borrowing conditions offered to home buyers. Housing starts should overpass 400 000 units in 2017 and recover the level reached before the financial crisis. Households who borrowed in the past to buy their home or a second residence will have the possibility to take advantage of the interest fall through a renegotiation of their loans when their contracts authorize it and if these ones carry fixed interest rates, which is the situation in a large majority of cases. The mechanism is simple. They can ask their bank to do it or, more frequently, they are approached by a competing bank which will reimburse the loan and offer to their new client a other loan with the same amount but with a much lower interest rate. It will generate a purchasing power gain and offer better solvability conditions because the borrower ability to reimburse will be better. That current move is without precedent by its magnitude. In one year, the amount of renegotiated credits has been multiplied by four to reach in January 23 billion, equal to more than half the total amount of real estate financing which, that month, was 37.6 billion.

The only real losers are the savers through the reduction of the remuneration of their deposits and, in some cases, pensioners when their benefits are based on a capitalization mechanism. Revenues used to pay pensions are decreasing as and when bonds carrying high interests are amortized and replaced by bonds with the very low current rates. It is the symmetrical mechanism of the one which delivered an advantage to the State. It is the reason why countries which have capitalization systems through pension funds, like Germany and Netherlands, are hostile to the ECB policy which weakens their pension systems and the purchasing power of their pensioners.

France, at the opposite, is one of the main beneficiaries because our pension system is based on repartition. Active persons are paying to the retired and contributions have no relation with the level of interest rates. But that supposes that France remains in the eurozone and in Europe. In the opposite case, it will create a general defiant feeling and investors will be more and more reluctant to lend to the State, at least until the situation is clarified. This prospect will provoke a very sharp rise of the interest rates France has to offer with catastrophic consequences on the cost of the public debt and private borrower attitude. Dissuaded by the costs of indebtedness and by the cautious attitude of banks which will put new restrictive conditions for them, households will stop to borrow to buy a home and both building industry and real estate will fall again in a crisis from which they just recovered. Regarding the State, it would be an illusion to believe that the printing press, due to our current account deficit, will be enough to fill the gap. Here are the real risks.    

 

 

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