It’s all Greek to the European bond market

Posted by Izabella Kaminska on Nov 17 14:17.

The spread between Greek bonds and German bunds widened to 153 basis points on Monday, the widest since July 17. And while analysts connected this to the deteriorating state of the nation’s finances, what struck us as interesting was the following statement from the Greek central bank (via Euro2day).
As Bloomberg reported:
Greece’s central bank asked domestic lenders to outline potential funding sources in coming months as the European Central Bank begins to tighten the liquidity it provides to Europe’s banking system, Euro2day reported.In a letter to the institutions, the Athens-based central bank said Greek lenders as a whole had borrowed amounts that were proportionally greater than other countries in the 16- nation euro area, the Web site said, without saying where it got the information. Greek banks have borrowed a total of 42 billion euros ($63 billion) of the 570 billion euros the ECB has pumped into the system, according to Euro2day.
Meanwhile, Danske Banks analysts noted the particular peculiarity that CEE fixed income markets did not follow the Greek bond price move higher:
We are a bit puzzled that CEE fixed income markets were totally unaffected by a pretty sharp rise in Greek bond yields on Monday on the back of continued worries over Greek public finances. Normally CEE yields tend to rise when peripheral euro yields — like Greek yields — rise. On Monday that was not the case and CEE yields in fact inched down.• Our EMEA FX Scorecard is still overall signalling continued bullish sentiment in EMEA FX markets, but we would caution that if concerns over the situation in Greece were to escalate, then sentiment could spill over to the CEE markets. Most at risk from a potential spill-over from Greece are Bulgaria, Romania, Hungary — and the small Balkan economies like Croatia and Serbia.
So does this mean that Greece, above all other eurozone countries, will be most vulnerable to tightening ECB liquidity conditions? BNP Paribas analysts on Tuesday certainly seemed to think so (our emphasis):
We see increasing long-term EUR downside risks due to the widening of inner EMU sovereign risks and weaker banks in the European periphery selling off hard in anticipation of the ECB reducing its liquidity provisions in money markets. Since the start of the crisis in September last year the ECB accepted weak collateral, providing liquidity to the fragile system.The aim was to reduce commercial credit risks, which was seen as one of the main conditions to get money markets functioning again. The money market has normalised and the ECB is likely to reduce the excessive EUR570bln reserves over time.Seven percent of excessive reserves are held by Greek banks, but when these reserves are drained these banks will have to look for funding at market prices. CDS spreads of weaker banks will widen as funding conditions become more expensive and the same applies for weaker sovereign debt such as Greece, Portugal, Spain and Ireland. The widening credit spread will highlight inner EMU divergence which in the absence of a central EMU fiscal authority will be a major issue and a long-term EUR negative.
And for those interested, here’s how sovereign Greek sovereign CDS responded to the news:

Related links:Europe’s north/south divide - FT Alphaville