By Francesco Canepa

FRANKFURT (Reuters) – Just as Britain and the United States face pressure from investors over increasing debt and persistent inflation, the euro zone appears to be relatively unaffected by market concerns, despite some underlying issues.

The UK and US governments have experienced a rise of 100 basis points in their 10-year bond yields since September, as investor anxiety grows regarding the fiscal strategies of Britain’s Labour government and Donald Trump’s upcoming administration.

Germany, being the euro zone’s largest economy and financial benchmark, has seen its borrowing costs increase by less than half of that, even with an impending general election that may favor far-right parties.

Investors feel reassured by Germany’s significantly lower government debt-servicing burden compared to Washington or London. Francesco Castelli, head of fixed income at Banor asset management, noted, “Germany is the only major economy globally capable of issuing more debt for public spending if needed.”

Italy and France, despite their high levels of debt, have similarly seen only minor increases in bond yields compared to Britain or the US. This may reflect some fiscal discipline being shown in Rome and Paris where the new government has committed to improving public finances.

However, the subdued bond yields might also be attributed to the euro zone’s sluggish economic growth, particularly in Germany, due to elevated energy costs and competitiveness challenges in major sectors like automotive and technology.

This stagnant economic landscape is set to lower inflation, which may prompt the European Central Bank (ECB) to rapidly cut interest rates in the near term.

In contrast, the US economy continues to surpass expectations with robust growth, leading economists to believe it is on track for a higher neutral interest rate—one that balances the economy effectively.

Incoming protectionist measures from Trump could exacerbate US inflation by raising import costs, maintaining the Federal Reserve’s higher interest rates longer and increasing borrowing costs.

Forecasts indicate that the Fed may only lower its key rate once or twice in the coming year, likely keeping it around 4.0%. Meanwhile, the ECB is predicted to reduce its policy rate four times over the same period, bringing it down to 2.0%.

Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, stated, “In the US, every piece of positive news signals stronger structural growth, potentially raising the neutral rate to between 3% and 4%.” He also highlighted a lack of optimism regarding growth prospects in Europe, referencing an ECB survey that indicates a long-term policy rate expectation of just 2.0%.

However, developments could shift either way, especially with uncertainty surrounding Trump’s policies, including threats of heavy repercussions for Europe’s significant trade surplus with the US.

Interest rate discrepancies also have limits, as rising US yields tend to strengthen the dollar, thereby elevating imported inflation in Europe, notably through energy prices.

“Six consecutive weeks of rising yields in Europe represents the longest stretch since September 2022 and contradicts the common perception that the second-largest economy in the world is failing and inflation is under control,” noted Societe Generale in a client briefing.

On a positive note, Pictet’s Ducrozet remarked that Germany could emerge from its economic stagnation if the forthcoming government opts to utilize its fiscal capacity for investments, thereby enhancing growth and inflation expectations. This scenario would likely lead to higher long-term rates, which he described as a potential “measure of success” rather than a problem.