June 19, 2018 / 7:39 AM / a year ago

UPDATE 3-Trade war fears boost demand for core European debt

* Escalating trade conflict fuels demand for safe-havens

* German, US 10-bond year yields hit 2-1/2 week low

* Most other euro zone bond yields down 2-3 bps

* Draghi dovish at Sintra, euro slips

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates throughout, adds Italy yield rise)

By Abhinav Ramnarayan and Dhara Ranasinghe

LONDON, June 19 (Reuters) - Core euro zone government bond yields fell across the board on Tuesday as escalating trade tensions between the United States and China, the world’s top two economies, lifted demand for safe-haven debt.

U.S. President Donald Trump’s threat to impose a 10 percent tariff on $200 billion of Chinese goods prompted a swift warning of retaliation from Beijing, and has driven investors to flee assets perceived as higher-risk including equities, emerging markets and commodities.

With world shares down more than 1 percent and Chinese stock markets suffering their worst single-day drop since February , investors sought safety in better-rated government bonds such as those issued by the United States and Germany.

“You only have to look at how far the main Shanghai index has fallen to see that people would probably want some safe-haven assets at this point,” said DZ Bank analyst Andy Cossor.

Dovish comments from European Central Bank chief Mario Draghi added to downward pressure on euro area bond yields and the single currency.

Germany’s 10-year bond yield, the benchmark for the region, hit a 2-1/2 week low of 0.35 percent before trading around 0.37 percent by session close — down 2.5 bps on the day. The yield was down for a sixth straight session.

Most other high-grade euro zone government bond yields fell 2-3 bps.

U.S. Treasury yields also slipped, with 10-year yields hitting a 2-1/2 week low of 2.85 percent.

“The trade issues have been bubbling away in the background — and Trump has certainly turned up the heat on that topic,” Cossor of DZ Bank said.

“If it were to develop into a more serious trade conflict, it could slow the pace of economic growth, we could see more demand for bonds.”

Growth fears were also voiced by ECB policymaker Jan Smets who described the trade tensions as “clearly a downward risk” for the world economy

The exception to Tuesday’s general picture of falling yields was Italy. Barely recovered from an end-May selloff driven by a surge in political risk, two-year Italian yields jumped by around 10 basis points to a session-high of 0.67 percent before easing slightly to 0.63 percent.

Ten-year yields traded around 2.56 percent, having earlier risen above 2.61 percent.

“We’ve got a general risk-off tone, so I think it’s just that mood affecting Italian bonds. Given the recent events in Italy, their bonds are particularly sensitive,” Rabobank strategist Lyn Graham-Taylor, said.

Bonds from Spain and Portugal, however, traded in line with northern European peers, seeing 10-year yields decline around 2bps .

Comments from French President Emmanuel Macron that a new joint euro zone budget agreed on Tuesday by France and Germany will be operational from 2021 also helped boost sentiment towards European debt.


German 10-year yields are down more than 10 bps since last Thursday when the ECB said it would end its 2.6 trillion euro bond purchase scheme by year-end but pledged to keep interest rates unchanged at least through next summer.

The ECB’s wording has pushed back rate hike expectations by three months to September 2019.

On Tuesday, Draghi told the ECB’s hallmark policy forum in Sintra, Portugal the bank would be patient in tightening policy further. Market pricing for the first post-crisis rate hike was consistent with the ECB’s aim to move gradually, he added .

“What’s been said by Draghi and other ECB officials hasn’t changed our view that they could hike in the autumn of next year,” said Orlando Green, European fixed income strategist at Credit Agricole.

Reporting by Abhinav Ramnarayan and Dhara Ranasinghe; Graphic by Sujata Rao; Editing by Alexander Smith

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