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Euro Inflation-Linked Market Poised To Swell

European sovereigns are expected to ramp up sales of inflation-linked bonds referenced to domestic consumer price indices this year, according to sell-side analysts.

European sovereigns are expected to ramp up sales of inflation-linked bonds referenced to domestic consumer price indices this year, according to sell-side analysts. The move would come in response to a sharp increase in demand for such bonds from new investors in the market--namely, specialized inflation-linked funds which invest only in products linked to consumer price indices. Such funds now represent a third of the buyers in this market, up from just 7% a year ago.

So far only France has issued euro-denominated bonds linked to the French consumer price index; all other euro-denominated inflation-linkeds have referenced the European Monetary Union ex-tobacco index of consumer prices. Outside the eurozone, the U.K. regularly issues sterling inflation-linked bonds referenced to the U.K. CPI, and is planning to issue its first ultra-long dated linker as early as this summer (BW, 5/23).

Germany, whose Ministry of Finance announced last year that it would issue an inflation-linked bond in 2005, could be the first to issue a euro-denominated bond referenced to German CPI. Stefan Olbermann, spokesman for the ministry, said it is too early to comment on the precise timing or form of any inflation-linked issuance from Germany.

The market for inflation-linked bonds referenced to 'new' indices could be as large as €16 billion, or 10% of the existing outstanding volume of euro-denominated inflation-linkeds, estimated Luca Jellinek, analyst at ABN AMRO in London on the inflation solutions and structuring team.

Specialized inflation-linked funds are hungry for new issuance linked to domestic CPIs, as this would broaden the range of inflation products and strategies available to them to produce relative outperformance in their portfolios. At present, they are largely limited to doing curve or cross-market trades on just two indices, and the introduction of products linked to for example German, Italian, or Danish CPI would greatly increase their options. "Whereas traditional investors use linkers as a diversification bet, inflation indexed asset managers try to outperform an inflation-linked benchmark--and these managers have relatively few opportunities to add value," noted ABN's Jellinek.

While demand for domestic indices has outpaced supply until now, analysts feel the tide is about to turn. "Our perception is that issuers will increasingly step up and meet demand," said Brice Benaben, global head of inflation solutions and structuring at ABN.

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