By Yoruk Bahceli and Dhara Ranasinghe
LONDON (Reuters) - Signs that the European Union may jointly fund the bloc's response to the energy crisis would mark the next milestone on the path towards permanent joint debt sales in the bloc.
Last week, European Economic Commissioner Paolo Gentiloni and Internal Market Commissioner Thierry Breton called for joint borrowing to finance a response to the energy crisis, which has raised recession risks.
The idea resurfaced again after Bloomberg reported on Monday that German Chancellor Olaf Scholz will reverse the country's position and support EU debt issuance if new funds are disbursed as loans, not grants. But a government source told Reuters Germany has no plans to back such a joint issuance and a spokesperson said member states could use money remaining in the EU's recovery fund.
"The genie is out of the bottle. This is probably going to come in some form," Danske Bank chief analyst Piet Christiansen said.
Here's a look at the significance behind a possible shift in Germany's stance.
1/ Why would a shift in Germany's position matter?
While supporting a post-pandemic recovery fund that gave member states access to grants and loans, Germany and other richer bloc members stressed this was a one-off and opposed further shared borrowing or a move towards a fiscal union.
A shift from Germany would be a powerful signal of European cohesion, coming in response to criticism from EU peers of its energy support programme dwarfing French and Italian ones.
Further joint issuance would help indebted member states that have sharply higher borrowing costs than top-rated Germany and so have less leeway to respond to the energy shock. And it would expand Europe's pool of safe assets, lifting the euro.
2/ But the EU already issues joint bonds?
Indeed. The EU issues joint bonds for an up-to 800 billion euro ($879 bln) post-COVID recovery fund, on top of 92 billion euros sold for its SURE unemployment scheme. But there are no plans for significant further issuance or making the facilities permanent.
However, Russia's invasion of Ukraine and the resulting energy crisis have raised calls for further bond issuance since it increases demand for funding in defence and energy security.
3/ How would joint issuance be funded?
EU officials calling for joint borrowing said it could resemble the SURE work programme.
To fund SURE, the EU sold bonds in response to loan requests and transferred the proceeds directly to the countries on the same terms it received on the markets.
4/ What does this mean for markets?
German bond yields jumped after Monday's report as investors bet further fiscal spending will lead to more rate hikes.
But Italy's borrowing costs fell and the risk premium over Germany tightened. Covering some of the debt poorer member states would otherwise have to issue for the energy crisis would take the heat off highly-indebted states such as Italy.
Italy currently pays 4.7% on 10-year debt, while the EU pays 3.2% -- that lower borrowing cost would get passed on to Italy through loans.
5/ Will this finally create a euro-zone safe asset?
Since October 2020, the EU has raised just 260 billion euros for the recovery fund and SURE. Any further issuance would boost the pool of high-quality EU bonds, especially as some 220 billion euros out of a 360 billion euros available in recovery fund loans have not yet been requested by member states, according to BNP Paribas (OTC:BNPQY).
That means recovery fund issuance may end up lower than 800 billion euros without changes to that programme, denting the EU's ambitions of becoming a top borrower.
But ultimately, a new programme is unlikely to scale up EU debt to a level where it can compete with Germany's 1.6 trillion euro bond market, the euro zone's safe asset.