Euro zone bond markets stabilise after ECB rate blow

Euro zone bond markets stabilised on Friday after a sell-off triggered by ECB President Mario Draghi saying he did not anticipate further interest rate cuts, which dampened enthusiasm for a wide package of stimulus measures.

However, two-year German bond yields were on course for the biggest weekly rise since early December, the last time the European Central Bank disappointed markets.

On Thursday, the ECB raised monthly asset purchases to €80 billion from €60 billion and cut its deposit rate by 10 basis points (bps) to -0.4 percent. It also shaved 5 bps off its main refinancing rate and the marginal rate.

The bank said it would buy corporate debt and offered to pay banks for lending to companies in the ailing euro area in a bid to kickstart growth and stave off the threat of deflation. Overall, it was much more than the market had expected.

But Mr Draghi’s comments that there may be no need for further rate cuts have grabbed the attention of investors.

Money market rates, bond yields and the euro all shot up, while stock markets were sold off. On Friday, however, 10-year German Bund yields were down 5 bps at 0.26 per cent, having traded between 0.16 per cent and 0.33 per cent on Thursday.

"Mr Draghi must be scratching his head with the euro rallying while Bunds and equities sell off sharply - despite his over-delivery on almost all accounts," Commerzbank rate strategist Michael Leister said.

“Upon closer inspection the dovish elements should prevail even with rate cuts off the table for now.”

Riskier bonds fared better than triple-A rated ones as they are more sensitive to the quantitative easing programme than to ECB rates. Italy sold the top planned amount at an auction, paying negative three-year yields for the first time ever.

Two-year German yields were flat at minus 0.46 percent, having risen more than 10 bps on Thursday. A 5 bps difference between the April and December Eonia rates still reflected a 50 percent chance of another rate cut by the end of the year, but the gap has shrunk from 15 bps before the ECB meeting.

Long-term inflation expectations only inched 2 bps higher to 1.49 percent, remaining well below the ECB’s inflation target of just below 2 percent.

“Investors are worried more generally about global central bank efficacy, and whether policymakers have enough ammunition to support growth and fight deflationary headwinds,” Heartwood Investment Management’s Jaisal Pastakia said.

Finland, Greece and Ireland are scheduled for rating reviews after the market close, with the focus on Finland, which may drop out of AAA bond indexes if Fitch downgrades it.

Finland’s 10-year yields were down 6 bps, in line with most euro zone peers, trading at 0.49 percent.

Reuters