Investors will have to buy a record amount of euro zone government bonds for a third straight year in 2025 and without the ECB in the market, potentially adding pressure on borrowing costs when political and economic uncertainty is high.
Bankers and analysts said they were confident markets can soak up the more than 660 billion euros ($694.52 billion) of net bond supply, with expectations for further European Central Bank rate cuts boosting government bonds' appeal.
However, they also say that high levels of bond sales could push up long-term borrowing costs relative to yields on short-term debt, which are anchored by central bank rate expectations, resulting in a steeper yield curve.
This means euro zone countries, grappling with weak growth and political uncertainty in Germany and France, may not see big declines in borrowing costs even as the ECB lowers rates.
"I think overall it will be absorbed," said Michael Krautzberger, global chief investment officer for fixed income at Allianz Global Investors.
"But it's one of the reasons why the euro curves could be quite a bit steeper as a combination of rate cuts at the short end and quite a bit of supply at the long end."
Analysts stressed that countries' borrowing plans remain uncertain, with U.S. President-elect Donald Trump putting pressure on Europe to increase defence spending and with France's 2025 budget in peril.
ECB OUT
Euro zone governments are set to sell around 1.26 trillion euros of bonds gross next year, banks estimate, down very slightly from 2024 as countries try to reduce deficits after spending big amid the shocks of COVID-19 and the Ukraine war.
Crucially missing from the market in 2025 will be the ECB, which since 2014 has hoovered up trillions of euros of bonds to support the bloc through successive crises.
The ECB has already stopped reinvesting the proceeds from maturing bonds in its Asset Purchase Programme and from January will do the same for its more flexible Pandemic Emergency Purchase Programme in a process known as quantitative tightening (QT).
Investors will have to absorb somewhere between 270 and 420 billion euros of bonds that the ECB might otherwise have bought next year, according to estimates from UBS, Bank of America and BNP Paribas. Different assumptions about the ECB's bond holdings produce different estimates.
Once redemptions, coupons, and QT are factored in, the effective bond supply to markets will be around 660 to 670 billion euros, according to the banks.
WHAT PRICE?
"An important feature of this year and a half has been quite a significant return of foreign investors," Italy's debt chief Davide Iacovoni told a conference in Brussels last week.
"We're in a situation where there's an expectation of lower interest rates and of course, Italy still pays quite an elevated spread," he said, referring to the higher yields available on Italian debt than on German peers.
UBS macro rates strategist Emmanouil Karimalis said Trump's threat to impose tariffs on the EU, which would dent the euro zone economy and potentially speed up ECB rate cuts, could boost safe-haven bonds.
However, Karimalis said investors may demand a higher return or "term premium" to lock in money for the long term - given the deluge of bond sales and heightened uncertainty.
CLOUDY OUTLOOK
Bond sales might have to rise if European governments increase military spending and if Germany, which holds a snap election in February, loosens long-standing debt rules.
UBS estimated Germany is currently set to reduce its gross bond issuance to 268 billion euros, down 7 billion euros from 2024.
France is likely to increase its borrowing slightly, even if Prime Minister Michel Barnier can pass his belt-tightening budget, UBS said. That means France would have the highest net supply in the euro zone - with redemptions, coupons and QT factored in - at around 202 billion euros in 2025, up 15 billion euros from this year, according to UBS.
Underlining the uncertainty around forecasts, French far-right leader Marine Le Pen on Wednesday threatened to seek to topple Barnier over the 2025 budget. French bond yields have risen sharply since the calling of snap elections in June that resulted in a hung parliament .
Ivan Morozov, sovereign credit analyst at T. Rowe Price, said political uncertainty had put off Japanese investors, traditionally an important French buyer.
"We need to get a bit more clarity on the French political situation before they come back to the market," he said.
($1 = 0.9503 euros)
