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Why Italy pays more than Germany

Governments in the euro area borrow in the same currency at different rates. The difference is called the spread.

The spread

If Germany’s ten-year bond yields 2.5% and Italy’s 3.5%, Italy pays one percentage point more. Germany is the usual yardstick in the euro area because markets see it as the safest borrower.

What moves it

The spread rises when markets worry about a country’s debt or politics. During the euro crisis, in November 2011, Italy paid about 5.5 points more than Germany. It narrowed as the crisis passed.

Ratings

Agencies such as S&P, Moody’s and Fitch grade borrowers with letters. From BBB− up is called investment grade; below it, high yield. Lower grades pay more because the chance of not being paid back is higher.

For you

A higher yield is payment for a risk. Before reaching for it, ask what you are being paid for, and whether one borrower’s trouble would hurt your plans. Many bond funds hold dozens of borrowers to spread that risk.

Key takeaways

  • The spread is what one borrower pays above the safest one.
  • Worry about a borrower widens it.
  • Higher yield always comes with a reason.