The article  was first published on OMFIF on  December10th , 2025

Conor Perry is Economist at OMFIF.

How could borrowing more make it cheaper to borrow?

The European Union has counterintuitively seen its cost of borrowing fall as it borrows more. In most cases, higher indebtedness tends to push borrowing costs up. The EU may be a special case.

Since 2023 when it began its ‘unified funding approach’ – issuing single-branded EU Bonds rather than separately labelled bonds for different programmes – it has issued more than €400bn in debt, bringing its total to just under €700bn and making it the fifth largest issuer in Europe. Simultaneously, the spread between 10-year EU bonds and 10-year Bunds has fallen from 65 basis points to around 40. This spread is the key indicator of the credit and illiquidity premium paid by the EU as an issuer. As it falls, all else being equal, so does the EU’s cost of funding.

To explore this dynamic, OMFIF built a model to quantify the relationship between the stock of EU debt and the EU-Bund spread. After controlling for confounding factors – such as the risk-free rate, the European Central Bank’s open market operations and key indicators of sovereign and quasi-sovereign risk in the euro area – we find that an additional €100bn in EU borrowing is associated with 8 basis points of tightening in the spread.

While this result is robust across a range of specifications, simultaneous trends in issuance volumes and spreads make it difficult to reliably identify a causal relationship. Yet, given that all gathered evidence points to more EU debt issuance being systematically associated with tighter EU-Bund spreads, it is worth asking: if this relationship were causal, what would be the transmission mechanism?

Anatomy of a spread

The components that comprise the spread over Bunds can be broken down into three categories. First, the liquidity premium is the compensation investors require to hold a security that cannot easily be sold at a fair market value; second, the credit risk premium is the compensation investors require to bear a greater probability of issuer default; and third, regulatory factors can introduce pricing distortions that drive yield differentials where two securities receive divergent treatment.

On the regulatory front, EU bonds and Bunds receive virtually equivalent treatment under European financial regulation. Although certain financial institutions may still treat them differently for internal risk modelling purposes, there is not an identifiable causal channel in this component of the spread.

Credit risk is also an inadequate explanation. Although EU bonds are seen as containing minimal credit risk, Germany remains the euro area’s benchmark low-risk sovereign. The EU will therefore continue to pay a credit risk premium in relation to Germany for the foreseeable future. Further, if credit were the operative channel, a larger stock of EU liabilities should widen the EU-Bund spread, not narrow it. This leaves liquidity.

Liquidity effects

The liquidity hypothesis explains the relationship between the EU’s debt stock and EU-Bund spreads, as operating through the effect of quantity on liquidity premia. As the stock of outstanding debt expands – assuming turnover velocity, the value traded as a percentage of the issuance size, does not fall – the absolute amount of trading increases. More active trading generally results in improvements in a security’s liquidity, as market-makers face lower inventory risk, and can quote tighter prices. Tighter prices manifest in declining bid-ask spreads which themselves lower execution costs and induce more trading – which supports liquidity.

Data from EU primary dealers show that the total turnover of EU bonds in the first half of 2025 surpassed €1tn, a 63% increase compared to the same period in 2024. This increase in turnover coincided with a 13-basis point fall in the average EU-Bund spread between the two periods. Simultaneously, turnover velocity increased 26% on the previous year – lending some credence to the liquidity hypothesis.

The European Commission may also be a proponent of this explanation, as it is taking steps to improve EU bonds’ liquidity. In October 2024, the EC joined Eurex Repo, bringing EU bonds into a centrally cleared financing environment that gives dealers predictable access to repurchase agreement financing and supports market-making. In September 2025, independent of specific Commission actions, Eurex launched a new physically delivered futures contract for 10-year EU bonds, following Intercontinental Exchange’s existing cash-settled EU Bond Index Futures launched in December 2024. These advancements in financial market infrastructure contribute to price discovery and facilitate hedging, further supporting liquidity.

Importantly, such advancements are possible only because of the scale of the EU’s issuance: Eurex membership requires sufficient issuance volumes to justify the infrastructure costs and derivative markets need enough of the underlying asset to attract meaningful market participation. If the liquidity hypothesis is true, it is these proximate effects that constitute the key to the causal mechanism. Under this interpretation, greater issuance compresses the spread by reducing the illiquidity premium via increased turnover and advancements in market infrastructure – channels that are contingent on the growing stock of debt.

A complicated relationship

Yet a growing debt stock seems far from assured. Next year will be the last year of net issuance from the post-Covid Next Generation EU fund, which has fuelled the rapid increase in issuance since 2021. While the Security Action for Europe programme, a €150bn facility for defence loans to member states, will begin disbursements in 2026, this programme is too small to ensure a reliable increase in issuance over a multi-year horizon. In the near term, if the liquidity hypothesis is correct, then we should expect the EU-Bund spread to narrow further over the course of 2026. However, if net borrowing declines from 2027, we may see these liquidity gains diminish.

There are some legitimate objections to the liquidity hypothesis, including the contention that EU-Bund spread compression reflects fleeting favourable conditions, rather than structural improvements in liquidity. However, scale clearly matters. A larger and more homogeneous pool of EU debt has supported turnover, narrowed bid-ask spreads and spurred advancements in financial market infrastructure. While we should not necessarily expect the relationship between the scale of issuance and the cost of borrowing to continue linearly and indefinitely, the erosion of the liquidity premium still has room to run.

With the EU still early in its development as a large-scale issuer, a larger debt stock would be likely to compress its liquidity premium further. Among the many good reasons to wish that the EU increases its borrowing, the possibility that greater borrowing could itself lower borrowing costs should find its place on that list.