Bloomberg News

German Two-Year Notes Decline as Traders Pare ECB Rate-Cut Bets

October 06, 2011

Oct. 6 (Bloomberg) -- German two-year notes slumped, pushing yields up to a three-week high, as traders pared back bets for an interest-rate cut from the European Central Bank after it kept its benchmark rate on hold at 1.50 percent.

Ten-year bunds also declined as ECB President Jean-Claude Trichet outlined policy tools to stem the debt crisis, including one-year loans for banks. Italian and Spanish government bonds rose as European banking stocks advanced for a second day amid optimism regional policy makers will take additional steps to shore up the region’s lenders. The Governing Council discussed the possibility of cutting interest rates, Trichet told reporters in Berlin.

“There is some disappointment that no rate cut materialized and the short end of the curve is suffering,” said David Schnautz, a fixed-income strategist at Commerzbank AG in London. “Also by emphasizing the difference between the non- standard measures and the interest rate, Trichet is not really leaving the door open for a rate cut as soon as next month.”

Two-year German note yields were 12 basis points higher at 0.62 percent at 4:23 p.m. in London after rising as much as 15 basis points to 0.65 percent, the biggest gain since Aug. 8. The 0.75 percent security due in September 2013 fell 0.235, or 2.35 euros per 1,000-euro face amount, to 100.25. Ten-year bund yields were 10 basis points higher at 1.94 percent.

Euribor Futures

Spanish 10-year yields fell nine basis points to 5.00 percent, while equivalent-maturity Italian yields dropped seven basis points, to 5.46 percent.

“There has been a discussion on the pros and cons of decreasing rates,” Trichet said. “We have decided by consensus to maintain rates.”

Euribor futures fell, pushing the implied yield on the contract expiring in December up by 11 basis points to 1.350 percent, signaling that investors reduced wagers on lower interest rates.

The median estimate of 52 economists in a Bloomberg survey was for the central bank to keep rates unchanged. Five predicted the central bank would cut borrowing costs to 1.25 percent, and six said it would lower the rate to 1 percent to boost growth.

ECB policy makers, who have raised borrowing costs twice this year, resisted calls for a rate cut. Instead, Trichet said the central bank will offer banks one 12-month loan, starting in October, and a 13-month loan in December. Both will be operated as fixed rate, full allotment operations. It will also start buying 40 billion euros of covered bonds in November.

Full Allotment

The Bank of England earlier increased the size of its bond- purchase program by 75 billion pounds ($115 billion) to 275 billion pounds and kept its key interest rate at a record low 0.5 percent.

“The 12-month full allotment and the covered-bond purchases were largely already priced in” to the market, said John Davies, a fixed-income strategist at WestLB AG in London. “There’s still risk momentum in the market on the likelihood of a European bank recapitalization program.”

The Bloomberg Europe Banks and Financial Services Index increased 3.3 percent as European Commission President Jose Barroso said officials are proposing coordinated action to recapitalize banks.

Bank Recapitalization

German Chancellor Angela Merkel said yesterday she supports recapitalizing European lenders “if there is a joint assessment that the banks aren’t adequately capitalized” and finance officials develop “uniform criteria.”

The yield on 10-year Belgian bonds was seven basis points higher 4.07 percent. Trading in shares of Belgian-based Dexia SA was suspended as of 3:55 p.m. in Brussels after the lender’s stock slumped 17 percent and De Tijd reported on its website that the government will nationalize Dexia Bank Belgium pending a sale.

Spanish three-year note yields fell 11 basis points to 3.63 percent after the Treasury sold bonds due in April 2014 at an average yield of 3.589 percent, compared with 4.813 percent the previous time Spain sold 2014 debt, on Aug. 4.

“This is encouraging for Spain in particular and for other peripherals in general,” Luca Jellinek, head of European interest-rate strategy at Credit Agricole SA in London, said in an e-mailed note.

Bunds have handed investors 8 percent this year, while U.S. Treasuries have returned 9.3 percent, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Spain’s bonds have returned 5.3 percent while Italy’s have lost 2.7 percent.

--Editors: Matthew Brown, Mark McCord

To contact the reporters on this story: Paul Dobson in London at pdobson2@bloomberg.net; Emma Charlton in London at echarlton1@bloomberg.net

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


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