The euro crisis is once again dominating the headlines. Renewed talk of a Greek exit, record yields for Spanish bonds and rising Italian borrowing costs have been splashed all over newspaper headlines. On July 25, the yield on two year bonds for Spain hit more than 7 per cent, with the borrowing cost for both the five year and ten year bonds exceeding 7.5 per cent. For Italy the rates were 5.2 per cent, 6.5 per cent and 6.7 per cent respectively.

Then, on July 26, as Mario Draghi, the ECB president spoke of doing “whatever it takes” to save the euro and making a reference to tackling problems of transmission of monetary policy being within the ECB’s mandate, the yields fell sharply. In this policy commentary we discuss 1) the relevance of high yields and 2) how they may be brought down and 3) the relevance, if any, of Draghi’s remarks.

No matter what the headlines say, the short-term impact of the rising yields on Spain’s actual borrowing cost is very limited. Spain is currently paying just 4.1 per cent on the stock of its outstanding debt which has an average maturity of 6.4 years. This means that if Spain can now borrow at an average rate of say 7.1 per cent (a full 3 per cent points above current costs) it would take more than six years for this to reflect in its average borrowing costs. This means that in any one year its actual borrowing cost is likely to rise only by about a sixth of that amount, around 0.5 per cent. If the panic in the markets does not worsen (which is a big if) Spain’s actual borrowing cost will only rise to a bit more than 4.6 per cent by July 2013 – which is a cause for concern, but not a cause for panic. What then is the problem? Why the near panic?

Read more at Business Spectator.