France is preparing its first issue of index linked government bonds for launch later this year. Since the US Treasury started issuing inflation linked debt, the product has gained popularity with investors worldwide. Will other European governments follow suit?
Will inflation linked bonds be the next fashion among the 11
European governments taking part in Emu? It will probably depend on
the success of France's inaugural issue, which is planned for later
this year or the beginning of next.
Apart from the UK, no other EU government has regularly issued
index linked debt but interest in the product has increased since
the US government's decision a couple of years ago to start issuing
TIPS.
And there is already certainly considerable enthusiasm among
European governments to follow the US's lead. With inflation rates
in Europe at historically low levels but real interest rates still
relatively high, they view this as an easy way to cut their
borrowing costs.
That is because investors, in theory at least, would be willing to
accept lower real yields if they knew they were protected against
an uptick in inflation. And with private pension funds set to be
established soon in several European markets, there is a strong
potential investor base.
For the French government, inflation linked debt offers it a way of
standing out from other European borrowers at a time when most
governments are taking very similar steps to modernise their debt
markets.
Some bankers believe there is investor demand for index linked debt
- even though inflation is low. "The economy is in the middle of a
recovery and you know what that means in terms of inflation," notes
Denis Prouteau, head of government bond trading at Banque Nationale
de Paris.
"There is also interest from investors because of the long term
nature of these bonds: everybody seems to have a very good view on
what inflation will be in two years.
"But if you ask them to put a figure on what the inflation rate
will be in five, 10 or 15 years' time they will find it a great
deal more difficult."
Bankers expect to sell the inaugural French issue to a range of
institutions, including funds that have so far invested in
alternative inflation hedges - such as real estate or equity.
Prouteau foresees interest from retail investors as well.
However, not all French bankers believe the product will work. "I
would be much more interested if they issued a bond linked to the
unemployment rate instead," jokes one capital markets official,
"but not this. I do not see what value it adds."
Index linked debt, he reckons, is a retrograde step at a time when
inflation has been all but eliminated in Europe. "If institutions
are looking for preservation of the real value of their capital,
they will move into the equity market, not buy this," he
argues.
The French government has not yet disclosed at what maturities it
plans to issue index linked debt or the precise structure of its
issues, but they are expected to resemble UK index linked issues
with coupons made up of a fixed spread plus the latest CPI index -
with the principal redemption indexed to CPI.
"They should issue at longer maturities - five years and beyond -
to attract the real estate and equity style investors," says one
French banker who believes that the product will be a success.
