The interest rate that the Spanish government pays on its public debt has been on the rise, even as the European Central Bank (ECB) has been cutting its official interest rates for over a year.

This increase, while occurring at a slower pace, remains persistent.

As of April, the average interest rate on outstanding debt reached 2.28%, the highest figure seen in six years since April 2019. In the past 12 months, this rate has increased by 18 basis points and has risen by 8 basis points so far this year.

This upward trend is driven by the higher refinancing costs associated with medium- and long-term debt instruments, such as bonds and obligations.

Most of the debt that is currently maturing was issued during a period when the ECB implemented a zero interest rate policy.

For instance, a ten-year bond issued in April 2015 had an average yield of 1.3%, while the most recent ten-year bond issued in April 2023 was placed with an average interest rate of 3.3%.

This results in a differential of 210 basis points, indicating that refinancing costs are likely to continue increasing for an extended period.

While it is projected that the ECB will continue to lower interest rates, with two additional cuts expected in the coming months bringing rates down to 1.75%, the period from 2015 to 2020 saw a consistent decrease in the cost of issuing debt due to the ECB's expansive policies, particularly the liquidity-enhancing programs.

In December 2020, the Treasury managed to issue ten-year bonds at negative yields, a historic occurrence that is unlikely to be repeated in the near future, especially against the backdrop of ongoing inflationary pressures that complicate the ECB's ability to adopt a similarly expansive monetary policy.

Consequently, this segment of debt is expected to become more expensive over at least the next five years.

Short-term Treasury bills now represent the only savings source for the public purse.

The cost of short-term debt is volatile, as it is refinanced every few months.

Currently, these are being refinanced at rates lower than those at which they were originally issued.

For example, 12-month bills are being placed at rates below 2%, compared to 3.4% a year ago.

However, the challenge with these short-term bills lies in their reliance on sustained declines in interest rates to lower the average cost of the Treasury’s debt.

Expectations among experts and markets suggest that the ECB may halt rate reductions, with little more than a 50 basis point cut anticipated.

This indicates limited potential for cost savings from short-term bills.

The most significant increase in financing costs has been observed in medium-term instruments (ranging from two to five years), as these are being refinanced after being issued during the pandemic under the ECB's intervention.

The average interest rate for this category exceeded 2% in April for the first time since 2016.

The Spanish government acknowledges that the cost of interest payments on debt will increase at a faster rate than nominal GDP (which combines real growth and inflation) this year.

According to a recent fiscal plan report submitted to Brussels, interest expenditure is expected to rise from 2.4% in 2024 to 2.7% in 2025, marking the highest cost since 2016. This estimate may be somewhat inflated to allow the government to present improved figures by year-end.

Nonetheless, it is anticipated that the long-term cost of debt will increase.

In addition to rising interest rates, the nominal growth of debt exacerbates financial costs, with Spain's public debt approaching 1.5 trillion euros, representing almost a 70% increase since a decade ago.

A peculiarity of the current year is that short-term bills are now yielding less than medium- and long-term debt.

During the inflation crisis, the yield demanded for short-term securities surged amid expectations of a temporary price spike, with the Treasury at one point paying 3.7% for three-month bills.

Currently, short-term instruments are less costly than medium- and long-term bonds, reintroducing a risky incentive for the government to shorten the maturity of its debt to reduce financial costs.

Thus far, the government has maintained a preference for long-term securities, with the average maturity of debt remaining close to eight years.

However, the current economic environment tends to make long-term issuance more expensive, marking a contrasting situation to previous inflationary periods.

Observers are monitoring how the government will approach debt issuance strategy moving forward.