January 11, 2013 / 9:11 AM / 5 years ago

EURO GOVT-Cautiously upbeat ECB, periphery sales hurt Bunds

* Bund futures at five-week lows on ECB, Spain sale
    * Strong Italy debt sale could keep Bunds in retreat
    * Three-yr Italian borrowing costs set to fall at auction

    By Emelia Sithole-Matarise
    LONDON, Jan 11 (Reuters) - German Bund futures fell to
five-week lows on Friday, extending losses after the European
Central Bank dampened prospects of an imminent rate cut and gave
a slightly more upbeat view of the euro zone's economic outlook.
    The sell-off in the region's lowest risk debt could gain
momentum with Italy expected to draw strong demand at a bond
auction later in the day, following Spain's successful start to
its 2013 funding programme on Thursday.
    Bunds resumed last week's falls, propelling German two-year
yields to their highest level since October, after ECB President
Mario Draghi said policymakers were unanimous in holding
interest rates steady at their meeting on Thursday, easing
pressure for the bank to cut rates soon.
    He also said the economy would recover later in 2013 and
there were some signs of stabilisation.
    "Yesterday the market was pricing out any near-term rate
cuts and the periphery had a good day so it's all negative for
Bunds," a trader said.
    The Bund future was 35 ticks lower on the day at
142.36, its lowest since early December and adding to Thursday's
fall of nearly one point.
    "The Italian auction is pretty small so it will go well so
presumably Italy and the periphery will remain supported so
things might be a bit fragile for Bunds." the trader said.
    German 10-year yields were 3 basis points
higher at 1.59 percent while two-year yields were up 1 basis
point at 0.11 percent, their highest since late October.  
    The trader and some strategists said the return in two-year
yields into positive territory could lure back some investors
into the front end of the German curve, given that official
interest rates are set to remain at historic lows for an
extended period.
    "Draghi's comments saying the decision on rates was
unanimous and there was no debate on rate cuts is a significant
change from December. But the door is not completely closed to
further rate cuts but the market has to reassess the situation,"
said Patrick Jacq, a rate strategist at BNP Paribas.
    In higher yielding euro zone bonds, Italian yields held
steady before an auction of up to 3.5 billion euros of its 2015
bond and up to 1.5 billion euros of two five-year floating rate
CCTeu notes. 
    Borrowing costs for the three-year paper are expected to
fall below 2 percent to levels last seen in March 2010,
benefiting from the improved demand for lower-rated debt since
mid-2012 after the ECB pledged to do whatever it took to save
the euro followed up by a new bond buying scheme.
    Spanish 10-year yields were also unchanged on
the day at 4.92 percent, having fallen the most in a day in
nearly three months on Thursday after a strong bond auction.
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