Traders and analysts in financial markets expect the inconclusive election result to trigger a rise in the cost at which the State borrows from investors.
At issue, they said, was the length of time it takes to form a new government and the likely durability of that administration.
Although the interest rate on Irish bonds remained close to a record low for most of the campaign, market participants said uncertainty over the formation of the next government was likely to put pressure on national borrowing costs.
As political leaders assess the fallout of the election, traders do not expect to see radical increases in interest rates. They warned, however, that a prolonged bout of uncertainty could undermine international confidence in Irish debt.
Investors were likely to add “political risk” into the price at which the State’s bonds change hands, they added. “We’re expecting yields to go up vis-à-vis peers in the euro zone,” said a senior Dublin-based bond trader. “It’s just uncertainty – and if there’s one thing markets hate it’s uncertainty.”
While the high national debt means the State is heavily exposed to any negative market sentiment, the European Central Bank provides some protection as it is buying bonds in a campaign to revive the euro zone economy.
Market reaction
Irish 10-year bonds carried an interest rate of just below 0.9 per cent at the close of business on Friday, as polling continued in the election. However, the Dublin trader suggested there would be little surprise if that rate rose by 0.2 percentage points as the market took stock of the result.
Dermot O’Leary, chief economist at Goodbody stockbrokers, said an alignment between Fine Gael and Fianna Fáil appeared to be the “only” option in the wake of the election. “Political instability is very much back on the radar when investors are looking at Ireland, particularly the Irish sovereign,” he said.
Asked about the prospect of rising bond yields, Mr O’Leary said he did not think such moves would be “dramatic” as the likelihood of a hung Dáil had been under discussion in markets.
“But as we think about the next few weeks, if it does take a few weeks to form a government, we may see a further drift out in bond yields,” he said. “Political risk hasn’t been a factor in five years. When sovereign investors look at risk they’ll look at economic risk, policy risk and political risk. This is one they’ll have to price in now.”
A US investor who holds Irish assets said it was very difficult to imagine at this point that sovereign borrowing costs would rise in coming months “to the extent that they harm the economy”. He added that a “large cash cushion” maintained by the National Treasury Management Agency provided a further layer of protection for the State.
However, the election result would be assessed internationally in the context of a rise in external risks. “It’s happening at a time when the [Irish] economy is strong, but there are risks in Europe, particularly with the [EU] referendum in Britain. We know that’s happening on June 23rd.”
ECB actions
This increase in risk was coming even as the ECB prepares to expand financial market operations to support the euro zone economy.
Citing high volatility in Portuguese borrowing costs after the election there, the US investor said ECB actions were “not necessarily enough” to curtail market pressure if it arises.
“The market does seem to be saying that even a very large asset purchase programme by the ECB does not put a ceiling on yields, does not put a ceiling on borrowing costs.”
