Bond Spreads as Predictors of Economic Activity in Eight European Economies

In this paper we examine the relationship between real activity and financial market tightness in Europe using data on 500 corporate bonds between July 1994 and May 2011 for Austria, Belgium, France, Germany, Italy, Netherlands, and Spain – and the United Kingdom. We evaluate the importance of bond spreads in predicting real activity at the individual country level, and find they are consistent predictors of real activity even when we include measures of monetary policy tightness, other leading indicator variables and factors extracted from a large macro dataset. Our results are consistent at different forecast horizons and are robust to different measures of the bond spreads. When we compare the predictive ability of the bond spread and the excess bond premium in individual countries within the euro area and outside the euroarea, we find that only the core European countries have similar predictive ability in the bond spreads. Other countries in the euro area, and the UK, do not have similar predictive ability in the bond spreads.