Zero-yielding German two-year bonds meet high demand

Wed Aug 20, 2014 7:08am EDT

* Investors bid for twice the amount at German auction

* German yields up to four years close to zero

* Markets attach higher probability of ECB QE (Updates with German auction details, new comment)

By Marius Zaharia

LONDON, Aug 20 (Reuters) - German two-year debt yields held close to 15-month lows just below zero on Wednesday, with record low money market rates and expectations of easier ECB monetary policy underpinning demand at an auction of similarly-dated bonds

Germany sold over 4 billion euros of a new two-year bond, with demand from investors double that amount despite the average yield and the coupon both being zero.

Data last week showing the euro zone economy stagnated in the second quarter even before the impact of sanctions imposed on and by Russia over the conflict in Ukraine cemented expectations European Central Bank interest would stay ultra-low for a long time.

It has also rekindled expectations the ECB could eventually print money to buy debt, or in market jargon, do quantitative easing (QE). A Reuters poll this week showed money market traders saw a 50 percent probability of QE in the next 12 months, up from a one-in-three chance in last week's survey.

"We've seen really bad growth numbers and these translate into deflation fears, which in turn fuel QE expectations," said Felix Herrmann, a market strategist at DZ Bank, adding that geopolitical risks also supported demand at the German auction.

"All that argues for lower German yields for shorter and medium term maturities. There are few, if any, reasons for Bund yields to rise."

Two-year bonds yield minus 0.004 percent in the secondary market, meaning buyers will get slightly less money than they invested when the bond comes due. They first traded negative at the height of the euro zone debt crisis in 2012.

Only five-year German bonds and longer yield more than zero.

Some banks may prefer to buy such assets rather than being charged 10 basis points for keeping the money in the ECB's deposit facility - a result of the central bank's unprecedented deposit rate cut into negative territory in June.

"This is a combination of expectations of very low rates for a very long period of time but also a reflection that the market has raised the odds of the ECB being drawn into taking more serious action," said Elwin de Groot, a senior market economist at Rabobank in Utrecht.

The overnight bank-to-bank Eonia lending rate fell to a new record low of 0.005 percent, reflecting abundant spare cash in the euro zone banking system. So-called excess liquidity is around 134 billion euros and the ECB is set to make up to 1 trillion euros of cheap loans (TLTROs) available from September.

ECB easing expectations pushed other euro zone yields lower. Spanish, Italian and Portuguese 10-year yields were down 2-5 bps. (Reporting by Marius Zaharia, editing by Nigel Stephenson)

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