May 30, 2012 / 10:51 AM / 7 years ago

RPT-UPDATE 1-Irish yield curve inverts on referendum risks

* Irish yield curve inverts as nerves grow before referendum

* Surprise ‘No’ vote would cut off second bailout option

* Short term risks stack up in Ireland and across euro zone

By William James

LONDON, May 30 (Reuters) - Ireland’s two-year borrowing costs have risen above its 10-year bond yields for the first time since January on fears of a shock ‘No’ vote in Thursday’s referendum on new EU fiscal rules which could threaten the country’s access to further bailout funds.

Polls show the Irish public is expected to back a European Union fiscal treaty designed to prevent the chronic overspending by euro zone governments that laid the foundation for the region’s debt crisis, now in its third year.

But if voters who sensationally rejected two previous European treaties in 2001 and 2008 surprisingly say ‘No’ to stricter budget discipline, Ireland would cut itself off from new bailout funding when its current aid deal expires next year.

“It’s not inconceivable that the ‘No’ vote will win and so I think things are going to remain uneasy until we see the outcome of the referendum,” said Alan McQuaid, chief economist at Bloxham Stockbrokers in Dublin.

The two earlier treaties were passed in repeat votes, but the government insists there will be no second chance this time.

Ireland’s property crash forced it to seek aid in late 2010 from the EU and International Monetary Fund, which imposed tough austerity measures that have angered voters.

Its bailout deal expires in 2013, after which Ireland is supposed to resume borrowing in the bond markets to fund itself. But with the euro zone’s debt problems still far from resolved it is unclear whether it will be able to do so.

The Irish debt agency said last week that the country would probably be unable to re-enter bond markets at sustainable rates if voters reject the treaty.

The Irish bond yield curve inverted on Wednesday, when two year borrowing costs rose 18 basis points to 7.448 percent, above the 10-year yield of 7.435 percent.

An inverted yield curve can indicate that investors see greater risks to the repayment of their cash in the short term than over a longer time frame - a trend exacerbated at present by the widespread doubts over Greece’s euro zone membership.

“What we’re seeing is that people are more worried about getting their money back. What people see is that all the risk is near term,” McQuaid said.

The curve was last inverted between October and early January when fears about the euro zone’s ability to withstand pressure on Spain and Italy drove investors to sell bonds issued by all the region’s more risky states.

Analysts said that broader problems in the euro zone were again adding momentum to the Irish curve-flattening, which despite opinion polls supporting a ‘yes’ vote has been accelerating since early May.

“If you can imagine a general risk-off environment, investors aren’t really going to be hugely reassured by just opinion polls against the possibility of a shock result,” said Austin Hughes, chief economist at KBC Ireland

Spanish and Italian bond yield curves have also flattened since Greek elections on May 6 raised the risk that a country could leave the currency bloc for the first time.

The rising cost of bailing out Spain’s banking sector has also driven investors away from the bloc’s more risky sovereign borrowers.

As a result, even if Ireland backs the EU fiscal pact, short-term worries are unlikely to ease much, analysts said.

In the event of a shock rejection, doubt over Ireland’s ability to plug its funding gap when the bailout programme ends would probably drive short-term yields even higher.

“Irish bond yields are already elevated so there is a significant degree of risk already priced in but the likelihood is that you would find a further move,” Hughes said.

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