EURO GOVT-German bonds rally on talk of ECB monetary easing

Wed Nov 30, 2011 7:59am EST

Related Topics

* German bonds rise on talk of ECB monetary easing next week

* Markets uncertain about EFSF's ability to raise cash privately

* ECB seen intervening to cap rise in Italian bond yields

By Ana Nicolaci da Costa

LONDON, Nov 30 (Reuters) - German government bonds rallied across maturities led by the short-end of the curve as talk that the European Central Bank would ease monetary policy next week pushed yields sharply lower across the curve.

German bonds had already been underpinned in early trade and the European Central Bank intervened to cap a rise in Italian and Spanish bond yields on scepticism that an agreement on boosting the firepower of the euro zone rescue fund would be enough to draw a line under the euro zone debt crisis.

The ECB will cut interest rates next week and throw more funding lifelines to stressed banks toiling against the euro crisis, according to a firm majority of economists polled by Reuters this week.

"There's a rumour that the ECB are going to do some massive liquidity provision at the short end which is why short-dated Bunds have even gone negative in the one-year," a trader said.

"People like (ECB governing council member Christian) Noyer has been talking about sharp downturn and the growth outlook so they'll probably use that as an excuse to flood the market with liquidity and try to solve a lot of these problems."

German two-year government bond yields slumped 12.5 basis points to 0.32 percent, while five-year German government bond yields eased 15 basis points to 1.16 percent.

Ten-year German governmen bond yields shed 8.6 basis points to 2.2 percent pushing German Bund futures more than 100 ticks higher to a session high of 134.50.

"8 IS THE NEW 7"

Euro zone ministers agreed detailed plans to leverage the European Financial Stability Mechanism (EFSF) on Tuesday, but could not say by how much because of rapidly worsening market conditions, prompting them to look to the IMF.

Uncertainty remained over whether the EFSF would be able to attract private sector interest and on how the potential involvement of the IMF would be carried out.

"There were few surprises as far as the details about the EFSF leveraging are concerned (and there was an)official confirmation that the leveraging idea might run into practical limitations ... and that investor appetite is not yet ensured," Rainer Guntermann, strategist at Commerzbank said.

"It's still a bit unclear how this coordination with the IMF will look like, whether it will work."

Yields on Italian and Spanish debt edged back towards unsustainable levels, with the 10-year Italian yield rising 7 basis points to 7.36 percent.

The two-year yield was up 3.7 basis pouints at 7.25 percent but off the day's high at 7.59 percent earlier, with dealers saying the ECB had bought small amounts of Italian and Spanish bonds, targeting short maturities.

The direction of Italian yields from here depended largely on ECB intervention, said Lynn Graham-Taylor, strategist at Rabobank.

"They have already let it go to 7.5 (percent) ... it gets to silly levels if they don't stop it at 8, so perhaps a line in the sand at 8?"

"I think 8 is the new 7," he added. "Fundamentally Italy can obviously fund itself for a short-time at these sort of yield levels. It's so clearly unsustainable, it's really just a waiting game until something happens."

Spanish 10-year government bond yields were little changed at 6.46 percent.

MAKE-OR-BREAK

Against this backdrop, the pressure remains on the European Central Bank to buy bonds more aggressively and on politicians to agree on steps towards a fiscal integration.

Berlin and Paris aim to outline proposals for closer fiscal integration before an EU summit on Dec. 9 that is increasingly seen by investors as a last chance to avert a breakdown of the single currency area.

"You need a significant break in this pattern of ever increasing yields, sometimes tempered by promises and solutions put forward by politicians which never quite get there," Gary Jenkins, head of fixed income research at Evolution Securities said.

"I think that the ultimate (response) would be a proper move towards fiscal union with common European bond issuance and at the same time while that's being done the ECB scrapping its temporary and limited support and actually invoking more of a QE (quantitative easing) approach."

He said large institutions were more concerned now with capital preservation than actual trading, and that German Bunds, UK gilts and U.S. Treasuries were still the safest bets but all of them were now subject to risks.

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