Bloomberg News

German Government Bonds Rise as Traders Pare ECB Rate Bets

June 09, 2011

June 9 (Bloomberg) -- German government bonds rose on speculation the European Central Bank won’t increase interest rates as quickly as previously forecast.

Two-year note yields fell to the lowest this week and Euribor futures gained as the central bank said inflation is unlikely to rise above 2.3 percent in 2012, trimming a previous forecast for 2.4 percent, prompting traders to pare bets on increased borrowing costs. President Jean-Claude Trichet signaled the bank intends to raise interest rates in July by calling for “strong vigilance” on inflation.

“The 2012 forecast is little changed from March, casting doubt on how much tightening is needed to contain inflation over the medium-term,” said Nick Stamenkovic, a fixed-income strategist at RIA Capital Markets Ltd. in Edinburgh. “As a result bunds have rebounded.”

Two-year note yields fell five basis points to 1.62 percent as of 4:43 p.m. in London after rising as much as five basis points to 1.71 percent when Trichet began speaking. The 10-year bund yield was three basis points lower at 3.03 percent. The 3.25 percent security due July 2021 gained 0.225, or 2.25 euros per 1,000-euro face amount ($1,450), to 101.885.

While the ECB today raised its growth and inflation forecasts for this year, it predicted both will slow in 2012. The ECB increased its 2011 inflation prediction to 2.6 percent from the 2.3 percent predicted in March and left the forecast for next year at 1.7 percent. The 17-nation euro-area economy will probably grow 1.9 percent in 2011, up from the previous 1.7 percent projection. Growth may slow to 1.7 percent in 2012, the ECB said, reducing its estimate from 1.8 percent.

‘Peripheral’ Meaning

Euribor futures rose, pushing the implied yield on the June 2012 contract down seven basis points to 2.07 percent.

The euro slid 0.4 percent to $1.4527 and 0.1 percent to 116.38 yen.

ECB policy makers are concerned about oil-driven inflation feeding into wage demands. The danger is that higher borrowing costs may exacerbate the sovereign-debt crisis that’s pushing Greece toward a default.

“The market is quite quick to factor in what a rate increase means for the peripherals and this is causing bunds to rise also on a flight to quality,” said Michael Leister, a fixed-income analyst at WestLB AG in Dusseldorf, Germany. “The ECB staff forecasts on 2012 inflation remain unchanged and this is the trigger and the main reason that bund yields are falling.”

Greek bonds fell for a third day, pushing the two-year note yield above 25 percent for the first time since June 1. Portuguese and Irish bonds also dropped.

Credit-Default Swaps

The cost of insuring against default on government debt sold by Greece, Portugal and Ireland surged to records, according to traders of credit-default swaps. Contracts on Greece soared 30 basis points to 1,522, Portugal increased 16 to 722 and Ireland rose 10 to 690 as of 2:30 p.m. in London, according to CMA. The Markit iTraxx SovX Western Europe Index of swaps on 15 governments rose 4 basis points to 203, the highest since Jan. 12.

European governments and the International Monetary Fund would lend as much as an extra 45 billion euros to Greece under the latest three-year plan to avoid the euro area’s first sovereign default, two people with direct knowledge of the talks said. Greek gross domestic product contracted 5.5 percent in the first quarter, data showed.

“There seems to be a lot of gloomier news about the Greek rescue package,” said Orlando Green, a fixed income strategist at Credit Agricole SA in London. “It’s sentiment rather than anything else, and we’ve also had disappointing GDP numbers.”

Greek Yields Surge

Greece’s two-year note yield climbed 181 basis points to 25.74 percent. Ten-year yields gained 51 basis points to 16.66 percent, the most since May 26.

Portugal’s 10-year bond yields climbed 17 basis points to 10.29 percent. They reached a euro-era record of 10.34 percent. The yield difference, or spread, between Portuguese and German 10-year securities widened to 730 basis points, the most since at least 1997, when Bloomberg began collecting the data. Two- year Portuguese note yields were 34 basis points higher at 11.40 percent.

Ireland’s two-year note yields climbed 22 basis points to 11.42 percent, while 10-year yields rose 21 basis points to 11.08 percent, the most since May 31.

Bunds rose on May 5 after the European Central Bank kept its key interest rate at 1.25 percent and Trichet signaled the bank would wait until after June to raise interest rates, wrong- footing some investors who had expected a quicker move.

German government bonds have handed investors a loss of 0.2 percent this year, while U.S. Treasuries returned 3.4 percent according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Greek bonds have lost 12 percent, the indexes show.

--With assistance from Abigail Moses in London. Editors: Mark McCord, Matthew Brown

To contact the reporters on this story: Emma Charlton in London at echarlton1@bloomberg.net; Lucy Meakin in London at lmeakin1@bloomberg.net

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net


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