An adverse shock in market sentiment toward the euro zone could result in an abrupt reversal of the recent declines in Irish bond yields and complicate the exit from its EU-IMF bailout.
Yields on Ireland's benchmark 2020 bond have fallen to 4.3 per cent from 8.5 per cent in the past year on improved sentiment towards euro zone peripheral countries and the promise of concessions from Europe on Ireland's debt pile.
But a slippage in Ireland's economic growth rate or an unexpected increase in the stock of public debt above its forecast peak of 120 per cent could complicate its efforts to exit its €85-billion euro ($112-billion) bailout at the end of the year, Ireland's Deputy Central Bank Governor Stefan Gerlach said in a speech in Berlin on Monday.
"There is … little, if any, safety margin and even a small adverse shock to market confidence in the Irish Sovereign could complicate the exit from the program," Mr. Gerlach said, according to a transcript on the bank's website.
"Any new development leading to a reassessment of euro area risk by financial markets could result in an abrupt reversal of the recent declines in yields," he said.
While recent improvements in sentiment have been self-fulfilling, a deterioration could create a "bad equilibrium" which would feed on itself, he said.
One risk is the high level of mortgage arrears in Ireland, which stands at 15 per cent, a problem exacerbated by the growing rate of long-term unemployed, he said.
A slowdown in Irish growth, which is "critically influenced" by growth in the euro area, could also undermine the country's efforts to cut its debt pile, he said.
Mr. Gerlach said European leaders could help Ireland by easing its debt burden through a retroactive direct investment by the euro zone's European Stability Mechanism (ESM) bailout fund in its banks and a restructuring of €31-billion in promissory notes.
Ireland hopes to secure a deal on the promissory notes – high-interest IOUs used to recapitalize the former Anglo Irish Bank, now called the Irish Bank Resolution Corporation (IBRC) – before their next payment falls due next March.
However, it has been struggling to secure support for ESM investment given German opposition to allowing the fund to cover such "legacy debts."
"Actions that would help reduce the sovereign-bank link and that would improve debt sustainability could greatly enhance Irish prospects of exiting the program on schedule," Mr. Gerlach said.