10-year government bonds yield of the four largest European countries by GDP

Source: BZM analysis based on S&P Capital IQ data.
10-year Italian, German, French and UK Government bonds; 12-month moving average; monthly measurement from 31/1/2010 to 31/12/2020.

The chart depicts the yield (12-month moving average) of government bonds with a 10-year maturity in Italy, Germany, France and Great Britain from January 2010 to December 2020. This yield, as we know, depends on numerous variables, including expected levels of inflation and GDP growth, the perceived risk of the country defaulting, and the monetary policies of central banks.

Looking back over the last 11 years, the yield on BTPs (multi-year treasury bonds) soared in 2011 and 2012, when it exceeded 7%, with a spread of over 500 basis points compared to its German counterpart. It took Mario Draghi’s famous line “Whatever it takes”, as then head of the ECB, to reassure the markets that every necessary measure would be taken to defend the eurozone. Since then, yields have fallen steadily and, after a period of instability that lasted about a year in Italy between 2018 and 2019, they rose again in early 2020 with the outbreak of the Covid-19 pandemic. This time it was the ECB’s massive new Pandemic Emergency Purchase Programme (PEPP) that calmed financial market tensions and drove down the yield and spread of Italian government bonds.

Company valuations use the yield of government bonds with a long maturity (e.g. 10 years), also calculated on moving averages at 3, 6 or 12 months to smooth the effect of contingent phenomena. The yield on government bonds typically measures the risk-free component of the cost of capital of the company or business being valued. It also incorporates a premium for the risk of default by the issuing government which, as the chart shows, can be quite different from country to country. In this sense, for the euro area, the most appropriate reference for estimating the risk-free return is the German Bund. Given the exceptionally low level of government bond yields at present – as a result of monetary policies supporting the economy during the pandemic – many experts suggest normalizing their value for estimating the risk-free rate.