The French state has issued February 1st a new ten years bond. The rate provided by the market came close to the 1% symbolic barrier, when, since the beginning of the year and during 2017 last quarter, if fluctuated between 0.50 and 0.75%. This move is not isolated. The growth acceleration in the U.S. permits to anticipate a more restrictive monetary policy by the FED. American rates, with the same duration are above 2.70%. The trend is the same in the United Kingdom but for different reasons. The devaluation caused by the Brexit has made imports more expensive and has ignited a nascent inflation, which has forced the bank of England to increase its interest rates at a time when growth tends to slow, on the opposite to what is happening in Europe. Interest rates in these two countries are by far above eurozone ones where we also see a narrowing of the spreads between countries. France is taking advantage of it. The spread with Germany is now inferior to the usual thirty basis points. This situation reveals the increased trust the country inspires to the financial markets. It also reflects the high financial saving rate of households who, through, their life insurance contracts are among the most important holders of the French public debt.
Is this new context foreshadowing an interest rate rebound to the level it reached before the financial crisis? Does that constitute a threat for France due to its high debt level? The answer to these two questions is no. Previously, a year ago, the ten years rate over passed 1% but fell quickly when ECB confirmed that it was going to prorogated until 2018 its quantitative easing policy through acquisition of public debts from eurozone countries. This policy is not forever but it is unlikely that during its next meeting in March, we see a toughening. Two options are possible. Mario Draghi may confirm that the end of its bond-buying policy will occur after next September but he will accompany his decision with a very accommodative message to avoid that financial markets interpret his announcement as a signal in favor of a restrictive monetary policy. That would immediately provoke a rise of the euro nobody wants in Europe. Mario Draghi may also leave the doubt about the end of the QE. In that case, we would see a loosening of the level of both interest rates and the euro.
Anyway, the target of an inflation lower but close to 2% is far from being reached. Globalization is putting a permanent pressure on prices through the competition it generates on goods and even on services. Innovation, whose consequences are quickly spreading from one country to another, thanks also to globalization, is once again contributing to it with, as an example, the fossil fuels and the shale revolution. New technologies are shortening distribution networks which offer consumers services with always better prices. These structural factors are powerful and we cannot imagine that their impact will disappear in the near future. The probability of significant rebound of interest rates is extremely low.
But even if such a rebound was supposed to come, the consequence on the debt cost in France and on the situation of the public finances would be very slow to be felt. That wouldn’t have any consequence for the time being because French debt carries fixed interest rates. What we pay are the interests on already issued bonds. As soon as long term interest rates are not superior during several years to the average interest rate the State pays to its creditors, which is around 2.25%, the annual cost of the debt will not increase and even will continue to fall. The amount of interest paid in 2017 was 38.9 billion euro and it will fall this year to 37.7 billion euro according to Agence France Tresor statistics. The reduction was about one billion each year for three years and the trend would have been more important if the State had not sold bonds in 2015 and 2016 carrying rates above market ones in order to cash emissions premiums to reduce its treasury needs. The State budget has lost on all counts. Premiums are not included in the deficit calculus. The reduction of treasury needs has deprived it from taking advantage from negative short-term rates offered by the ECB and these bond issuances generate accrued charges for the following years. In 2017, that practice, despite of the observations of the French National Accounts Body has not been abandoned and has represented 10 billion, against the double for the two previous years.
But the issuance strategy has also comprised a positive element. The average duration of the mid and long term State debt has been increased by almost one year and is now near to eight years. That will also contribute to reduce the future charges because all the issuances with maturities inferior to that duration carried negative or near zero rates. The free money era is still there.
The alarming message regarding the consequences of a rebound of interest rates is excessive for two reasons. Its probability is very low, even if bumps can occur on financial markets. And if that was to occur, the redemption, year after year, of the bonds issued in the past with very high interest rates, will lower during a long period of time the cost of the debt for the taxpayers. But, obviously, it is not a reason to loosen efforts in favor of a better management of public expenditures.