Bond market faces Euro 'instability'

The government bond market will be "dangerously unstable" after monetary union, and may fall victim to speculators as the ERM did in 1992, leading City economists warned this weekend, writes Richard Halstead.

Under the proposed system, to be discussed at the meeting of EU finance ministers in Dublin next Saturday, member countries will borrow money on the same terms but be subject to stringent financial controls on the budget deficits they would be allowed to run.

The market in EU government debt would begin in 1999 and replace national gilts markets in 2001. In theory, there would be a small difference between yields of German debt and that of some weaker economies.

But City economists are sceptical. "As long as countries can elect governments, there will be questions over their commitment," said Mark Fox, chief European strategist at Lehman Brothers. "You only need the threat of a country leaving EMU to cause the spreads within the system to become volatile."

The proposed stability pact, designed to keep EU countries' budget deficits within three per cent, will be as vulnerable as all previous efforts to control money markets, he said. "It will be a licence to speculate."

Other economists believe that the system might survive, but would be under severe pressure during the two year transition period when both Euros and national currencies were still in circulation. "The fundamental problem seems to be that it will remove the last macroeconomic tool from national governments," said Mark Cliffe, chief international economist at HSBC Markets. "One has to come to the inexorable conclusion that political union is required to make this system work."