Decomposition of the dynamics of sovereign yield spreads in the euro area

The article analyses developments in euro area sovereign bond markets observed during the financial and sovereign debt crises. Not only governments, but also banks, households and non-financial corporations were affected by the sovereign debt crisis. Regarding the private non financial sector in particular, the increased sovereign risk premiums resulted in temporarily higher bank lending margins from 2009 onwards in Belgium, Italy and Spain. By resorting to a macrofinancial modelling approach to decompose these sovereign risk premiums, it appears that fundamental economic shocks are the main drivers of sovereign premiums, although non fundamental shocks were particularly large during the sovereign debt crisis and stemmed mainly from redenomination risk. The significance of non-fundamental components of sovereign premiums nevertheless seemed to have dropped to very low levels by the beginning of 2015, partly due to the (unconventional) monetary policy measures adopted by the ECB (e.g. the announcement of the OMT programme and the expanded APP). However, sovereign premiums are still significant in the euro area periphery (notably in Italy and Spain) and seem to be explained largely by fundamental factors.