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German yields hit 1-1/2 year highs before ECB meeting
September 5, 2013 / 10:51 AM / 4 years ago

German yields hit 1-1/2 year highs before ECB meeting

* 10-year Bund yields above 2 pct; UK, U.S. yields rise

* ECB expected to keep soft tone, action seen unlikely

* Spanish debt auction goes smoothly

By Marius Zaharia

LONDON, Sept 5 (Reuters) - German Bund yields hit 1-1/2 year highs on Thursday as an improving economic outlook hammered top-rated bonds globally and investors expected little to counter the trend from central bank meetings later in the day.

British gilt yields and U.S. T-note yields US 10YT=RR hit their highest since July 2011 close to 3 percent.

The Bank of England and the European Central Bank are both expected to keep interest rates on hold, with the Federal Reserve seen the only major central bank to respond to the data by trimming monetary stimulus, possibly at its Sept. 18 meeting.

While the BoE is not expected to issue a statement after the meeting, ECB President Mario Draghi’s reaction to the recent market move will be closely scrutinised as it goes against his aim of injecting a “downward bias” on rates.

“Markets are reacting to the recent data improvement. Running into these central bank meetings there is little faith they are going to give us anything that can keep ... rates low,” RBS rate strategist Harvinder Sian said.

The ECB is facing higher money market rates than before July, when it took the unprecedented step of promising to keep interest rates low for a long time, in a bid to curb the impact from policy shifts across the Atlantic

Since then, forecast-beating euro zone data has renewed rising pressure on money market rates, which filtered through to longer-term maturities on the benchmark German yield curve, reflecting the fact that investors have brought forward expectations of a rate hike.

Tighter market conditions might create discomfort within the ECB, analysts say, as they threaten the euro zone recovery.

But with the ECB failing to agree on cutting rates in July, when they had “extensive” talks about it and when the economic outlook looked worse, analysts see little option for the bank other than just maintaining a soft tone in communication.

“(Draghi) will talk dovishly, but I think his attempts to keep a lid on ... rates will prove difficult,” RIA Capital Markets strategist Nick Stamenkovic said.

Sian at RBS said “the dovish tone from the ECB is an oxymoron,” adding markets lacked confidence in its promise.

German 10-year yields rose above 2 percent for the first time since March 2012 and were 7 basis points up on the day. Bund futures fell 60 ticks to 139.13.

Markets appeared to have cast aside worries about Syria for the moment even as a possible U.S. military strike moved one step closer after a Senate committee voted in favour of action.

DEBT AUCTIONS

While low-risk markets got pummelled, Spain smoothly sold the maximum 4 billion euros planned at an auction of five- and 10-year bonds, with borrowing costs falling on signs the recession-hit economy may have hit the bottom.

“These results... will serve to endorse if not further encourage the evident bullish momentum (in Spanish bonds),” Rabobank senior rate strategist Richard McGuire said.

The yield gap between Spanish and Italian 10-year bonds shrank to its tightest in 1-1/2 years of 2 bps last week due to the risk that a vote on whether to expel Silvio Berlusconi from the Senate could bring down the government.

Supply pressure in Spain widened the spread back to about 10 bps, but some analysts expect the move to reverse with the auction out of the way.

“The auction was very solid. Confidence is coming back into that market ... we do anticipate Spain should trade through Italy now,” Sian of RBS said.

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