Positive yield draws strong bids for German debt

LONDON/BERLIN Wed Oct 17, 2012 6:36am EDT

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LONDON/BERLIN Oct 17 (Reuters) - Germany sold 4.2 billion euros of two-year debt on Wednesday, drawing strong demand for its safe-haven bonds as a rise in yields above zero offset the impact of Spain retaining its investment grade credit rating.

Moody's Investors Service kept Spain's rating at Baa3, surprising some in the market who had positioned for the country at the forefront of the euro zone debt crisis to be downgraded to "junk".

Despite a weaker appetite for the least risky euro zone assets, the auction received bids worth 2.0 times the amount allotted to investors, just a shade less than at the previous sale on Sept. 19, but above the 1.87 average for 2012.

"It's a good amount given the positive news for Spain. Maybe some people were expecting a lack of interest but 8 billion (of bids) is a solid amount," ING rate strategist Alessandro Giansanti said.

"What's happened is that these yields are now above zero."

Whether investors prefer safe-haven assets, such as German bonds, or higher-yielding, riskier ones depends for the moment mainly on developments in Spain.

The recession-hit country is expected eventually to ask for a bailout -- a move that would allow the European Central Bank to buy its bonds and lower its borrowing costs.

However, the timing of the request is still uncertain. If Spain drags its feet, the risk is that the crisis worsens before it gets better, analysts say.

The prospect of ECB bond buying has, nevertheless, brought German two-year yields back into positive territory in recent weeks. The most recent flare-up in the crisis pushed them to record lows of minus 0.095 percent in early August.

The benchmark September 2014 bond, which carried a zero percent interest rate, sold at an average yield of 0.07 percent, compared with 0.06 percent last month and a 0.12 percent average for this year's two-year bond sales.

The ECB's plan is perceived as a significant step towards tackling the crisis and has complicated sales of longer-term German bonds, which offer below-inflation returns. Two 10-year German auctions were technically uncovered in September, meaning they drew bids worth less than the amount on offer.

However, demand for shorter-term German debt has stayed high throughout the year. Sensitive to the ECB's monetary policy, two-year bonds benefit from expectations that interest rates will remain low for a prolonged period, depressing yields.

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