Budget Concerns Put Dutch Bond Auction Under Scrutiny Next Week

-- Budget concerns turn focus on the Netherlands
-- Bond issuance from core euro-zone countries to dominate
-- New 10-year bund from Germany



FRANKFURT (Dow Jones)--The Netherlands's five-year bond auction Tuesday may draw more attention than usual as newly resurfaced concerns over budget deficits have put Dutch borrowing costs under some pressure.

The fading impact of the European Central Bank's cash boost has shifted attention back to economic fundamentals in the euro zone, putting pressure particularly on yields of peripheral countries such as Spain, which had to pay higher borrowing costs at a rather weak auction this week.

The Dutch minority government is currently in difficult talks about new cutbacks to meet the European Union's deficit target of 3% of gross domestic product, although a short interruption in the negotiation caused some unease among investors.

The talks, which are now in their fifth week, are troubled by divisions within the right-wing coalition and the supporting Freedom Party about the size and type of cutbacks. Analysts at Citigroup have recently said the Netherlands no longer belongs to the euro-zone core, mainly because of a weak economic outlook and shaky political landscape.

Dutch central bank chief Klaas Knot last week warned that the uncertainty has led to a slight increase in borrowing costs for the Netherlands and he urged the government not to delay spending cuts. The negotiations are expected to drag on for a couple of more weeks.

"Coalition politics have long been a feature of the Dutch government but that has not prevented a solid social compact and effective policy implementation over the medium term," said Luca Jellinek, head of European rates strategy at Credit Agricole CIB, adding that "it is absurd to characterize the Netherlands as anything but a 'core' country," as opposed to one of the weaker peripheral members of the currency area.

"Although the budgetary outlook and the current political and economic situation in the Netherlands raise some eyebrows abroad, the fundamentals still point out that the Netherlands belongs to the core of the euro area," Rabobank economists agreed in a note.

They said they expect the Dutch economy to climb out of the recession in the course of this year because of a gradual pick-up in exports, although for the year as a whole they forecast a 0.75% contraction, before a return to a 1% GDP growth in 2013.

During the crisis, Dutch debt has been a favored alternative to German bonds for investors who have been seeking safety but wanted higher returns than what rock-solid German debt would offer. Spreads between 10-year Dutch and German bonds currently trade at around 56 basis points, according to Tradeweb, up from levels of below 40 basis points at the beginning of the year.

Euro-zone government bond supply will total around EUR15 billion next week. On Tuesday, Austria will auction EUR1.32 billion of the 3.20% February 2017 and 3.40% November 2022 bonds, while the Netherlands will offer EUR2.5 billion to EUR3.5 billion of the 2.50% January 2017 Dutch State Loan, or DSL. Germany will launch a new, July 2022-dated 10-year bund Wednesday.

Austrian five-year paper has seen strong performance, but going into next week's auction, "we expect some supply concession, especially when compared to its nearest perceived credit counterpart--France," said analysts at RBC Capital Markets.

Rounding off next week's scheduled bond sales, Italy will auction Buoni del Tesoro Poliennali, or BTP, April 12 for series and amounts to be announced later Thursday.

"The improvement in Italy's perceived creditworthiness over the past few months is being put to the test," said Nicholas Spiro, managing director at Spiro Sovereign Strategy.