February 12, 2014 / 5:45 PM / in 4 years

Zero in sight for German 2-year yields after smooth debt sale

* Expectations of more ECB policy easing anchor yields

* New German 2-year bond finds strong demand at auction

* Treasuries, Gilts help drive Bund futures down 52 ticks

By Joshua Franklin

LONDON, Feb 12 (Reuters) - German two-year yields held near zero on Wednesday as a sale of new bonds offering wafer-thin returns met solid demand from investors who expect the European Central Bank to ease monetary policy further.

Shorter-dated debt outperformed 10-year Bunds, whose yields were dragged higher in the wake of weaker U.S. Treasuries and UK gilts after the Bank of England raised its economic forecasts and pushed up expectations of a rate hike next year.

Comments by ECB Executive Board member Benoit Coeure at a Reuters summit that cutting the rate the ECB pays banks for overnight deposits to negative was “a very possible option” kept German yields pinned down near 2014 lows.

Short-dated debt is usually more sensitive than longer-dated bonds to shifts in policy and demand for the paper is a significant indicator of market expectations of the central bank outlook.

The demand was on show in a German sale on Wednesday of just over 4 billion euros ($5.47 billion) worth of two-year Schatz notes, receiving bids for about 8.8 billion euros, higher than the 7.9 billion seen at a previous sale and a 2013 average of 7.8 billion.

The result looked particularly impressive given that the return on offer was a meagre 0.11 percent, analysts said.

“The ECB is clearly keeping the door open for a rate cut even though it doesn’t seem to be in a rush to ease policy. It’s continued easing bias which is giving good support to the short end,” said RIA Capital Markets strategist Nick Stamenkovic.

The ECB kept interest rates unchanged at its February meeting, but left the door open to further easing in coming months as inflation unexpectedly slowed to 0.7 percent in January, compared with a target of at or just below 2 percent.

Two-year Schatz yields help steady at 0.110 percent. They stood slightly above a 2014 low of 0.065 percent hit at the end of January right after the inflation data, but they are less than half where they ended last year.

Schatz yields are below one-week and one-month money market rates, for instance - an unusual yield curve inversion which some analysts say indicates expectations of further ECB easing are embedded in market prices.


Further along the curve, German 10-year yields were up 4 bps at 1.72 percent, stretching the yield curve by 4 bps to 161 bps, its steepest in about month.

Bund futures fell 52 ticks to a session low of 143.12, the biggest fall in just under a week. Traders pointed to weaker U.S. Treasuries and UK gilts for the decline.

“The ECB was laid back so this feels like a catch-up move with Treasuries and gilts,” said David Schnautz, a strategist at Commerzbank in New York. “This looks like a broader retreat of safe-havens.”

Elsewhere, 10-year Italian bond yields rose 4 bps to 3.74 percent as traders made way on their books for Thursday’s auction of 7.5 billion euros in bonds. They earlier hit their lowest levels in eight years.

“There’s growing evidence the worst is over in the peripheral economies. In an environment where investors are still hungry for yield pick-up peripherals continue to perform well,” said RIA Capital Markets’ Stamenkovic.

He added, however, that political instability and a review by ratings agency Moody’s on Friday could weigh on yields. Moody’s currently has a negative stance on the Baa2 rated economy.

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