Germany’s bailout plan could trigger a UK-style bond crash

Amid gloomy predictions of a recession in Germany and the wider region, analysts at a Wall Street bank have shared broader concerns about violent bond market moves and European governments looking to borrow large sums of money.

German Chancellor Olaf Scholz last week announced a package worth 200 billion euros ($198 billion) designed to help with rising energy prices. The “defensive shield” includes a brake on the price of gasoline and a cut in the tax on fuel sales.

The proposals could reduce inflation by 2 percentage points next year, according to Citi, but are unlikely to prevent an economic contraction. The package “may soften the looming recession but also poses risks, in our view,” Citi analysts said in a note published last Friday.

Those risks relate to the question of how the package will be financed and what that might affect inflation, German sovereign bond yields, the European Central Bank’s benchmark rate and the borrowing plans of other nations in the euro they can do the same.

“The risk is that others may follow suit,” Christian Schulz, deputy chief economist for Europe at Citi, told CNBC.europe street signon Monday.

Schulz pointed to the recent Bond market crash after unfunded tax cuts by UK government. Rate expectations and bond yields rose in Britain last month after a series of fiscal announcements. He had the Bank of England launch a new bond purchase plan, chaos in the mortgage market and speaks of a housing crisis.

Schulz said Germany could “afford” any debt financing thanks to its low debt-to-GDP ratio and lower external financing needs, but the package could open the door for less fiscally prudent countries to want to borrow heavily and issue new debt. debt, potentially leading to problems like those seen in the UK Citi predicts that German debt financing could also force tighter policy from the ECB, which could also cause yields to rise in the eurozone.

“The risk is that this same dynamic [seen in Britain] it’s also evolving on the continent now,” Schulz said.

“The way [Germany] want[s] do it is using an existing VPS [special purpose vehicle]an off-balance sheet fund…whether that will lead to loans or whether it will lead to guaranteed loans, because this fund can do both, we’ll see,” he added, referring to the €200bn plan.

German Federal Court of Auditors criticized the government and suggested that he had circumvented tax rules to finance the package, according to Politico.

Other banks and institutions pointed to the difficult environment in Germany, Europe’s biggest economy and a powerhouse for growth in the euro zone, which is now trying to abruptly abandon Russian fossil fuels.

Berenberg Economics said in a recent note that consumer confidence in Germany, and the euro zone in general, has slumped to a record low, which it said is “a prelude to recession.” In fact, the Institute for Economic Research predicts that investment will plummet by 25% and expects a German recession in 2023.

Deutsche Bank analysts estimate that the “defensive shield” could boost household income and limit the projected GDP decline in 2023 to around 2%. That’s better than his earlier forecast of a 3.5% contraction.