Most small euro zone countries' bond yield premiums relative to German benchmarks are likely to remain around current levels in 2004 unless Germany and France are penalised for breaking European budget rules, analysts said.
However, countries such as Greece and Italy which have specific problems of their own may see their debt markets do worse than their bigger rivals.
On Tuesday, the European Commission said it would mount a legal challenge to the decision by European Union finance ministers late last year to suspend disciplinary action against Germany and France, the bloc's largest two largest economies.
Should that succeed and result in fines being imposed on Germany and France, analysts reckon it would result in austerity measures in both countries, driving down their debt yields and leading to them outperforming smaller, so-called peripheral sovereigns.
"That is a significant issue, perhaps singularly the most important this year, because it would mean not only some negative news for Germany and France, it could also push out spreads at countries which continue to have a precarious state of finances, such as Portugal," said a trader in London.
Portugal's 10-year bond was six basis points above Bunds.
Barring a judgement against France and Germany, which is far from certain, many analysts see yield spreads holding steady.
"This should be a fairly steady year for most 10-year government debt spreads within the euro zone, boring as that may seem, unless Germany and France are fined," said Daniel Pfaendler, head of relative value strategy at Dresdner Kleinwort Wasserstein in Frankfurt.
The euro zone's smaller economies include Austria, Belgium, Finland, Greece, Ireland and Portugal. But there the similarity ends, as the budgetary and rating profiles betray differences and they are hardly one club.
Finland is one of the star performers at keeping its budget in line with the EU's Stability & Growth Pact and its 10-year government bond yield is currently below that of Germany's Bunds, the benchmark for the euro zone.
Meanwhile, Portugal and Ireland have both felt the heat of European Commission pressure to get their public finances in order in recent years. Irish bond yields now trade below Bunds.
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