Bond Spreads and Economic Activity in Eight European Economies

This paper provides a new insight into the relationship between financial market tightness and real activity using a unique new database extracted from Bloomberg to construct a credit spread index from 500 corporate bonds issued in eight European countries. We find that European bond spread measures have a significant negative relationship with four real activity measures at horizons of one quarter to two years ahead. The relationship is robust to inclusion of measures of monetary policy tightness, other leading indicator variables and factors extracted from a large macro dataset, as well as alternative measures of the bond spreads. These results provide strong support for models previously only evaluated on US data. We find that a sub-set of northern European countries have similar sensitivity of real GDP to bond spreads, but others have higher spreads and greater sensitivity to these spreads, which reveals a diverse response in Europe to financial market tightness.