Euro bond yields dive as Draghi comments feed QE speculation

ECB president’s comments fan speculation that Frankfurt is heading for monetary stimulus option

Mario Draghi, president of the European Central Bank, used last week’s high-profile central banking conference in Jackson Hole, Wyoming, to warn that investor bets on prices have “exhibited significant declines”.  Photograph: Bradly Boner/Bloomberg

Mario Draghi, president of the European Central Bank, used last week’s high-profile central banking conference in Jackson Hole, Wyoming, to warn that investor bets on prices have “exhibited significant declines”. Photograph: Bradly Boner/Bloomberg

Mon, Aug 25, 2014, 12:25

Yields on most euro zone government bonds hit record lows today as speculation grew that the European Central Bank was preparing a big programme of asset purchases to counter wilting inflation.

The yield on the Irish 10-year bonds dropped to 1.81 per cent at one stage this morning, the lowest since Bloomberg started tracking the bond data in 1991, keeping Ireland’s borrowing costs below that of the US and UK.

Germany, France, Italy, Spain and Portugal also saw their yields hit all-time lows.

Greek yields fell sharply but remained above this year’s troughs as a senior source said that Athens had near-term plans to sell debt.

In stronger language than he has used in the past, European Central Bank president Mario Draghi said last week at an annual meeting of central bankers in Jackson Hole, Wyoming, that the ECB was prepared to respond with all its “available” tools should inflation drop further.

This increased speculation the ECB could embark on a large-scale asset-buying scheme known as quantitative easing, or QE, to pump cash into the financial system and revive inflation.

“For sure Draghi sounded a little bit more open to doing more,” said Jean-Francois Robin, global head of strategy at Natixis. “The market is clearly buying the ... idea of QE.”

German 10-year yields fell 6 basis points to a record low of 0.93 per cent. The moves may have been exacerbated by the thin trading volumes caused by a bank holiday in London and could partially reverse on Tuesday, analysts said.

French yields fell 8 bps to 1.30 per cent, with the market shrugging off news that the government resigned.

President Francois Hollande’s office said a new government would be formed on Tuesday. “There are no real implications from that on the market because the market is in QE mood,” said Alessandro Giansanti, senior rate strategist at ING. “The ECB doesn’t have any other option left.”

The ECB cut all its interest rates in June and flagged measures to pump up to 1 trillion euros into the sluggish euro zone economy by offering cheap long-term loans to banks. The ECB has been struggling for months to lift inflation out of what it calls a “danger zone” of sub-1 per cent.

Euro zone consumer prices grew 0.4 per cent in July and are expected to post 0.3 per cent growth in August on Friday, a far cry from the ECB’s target of just below 2 per cent. Adding to the lacklustre euro zone picture, Germany’s Ifo business sentiment index dropped for a fourth straight month in August due to concerns about the Ukraine crisis and the impact of the sanctions and countersanctions Russia and the West imposed on each other. Despite the deteriorating economic outlook, investors grabbed even the higher-risk bonds in the currency union.

The higher probability of QE means that they can hope to sell the bonds to the ECB for a profit. Spanish and Italian 10-year yields fell 11-13 bps to 2.26 per cent and 2.48 per cent, respectively, while Portuguese yields fell 25 bps to 3.01 per cent. Taking advantage of the renewed demand, Greece aims to reopen its recent three- and five-year bond issues in the next two weeks to raise as much as €1.5 billion. But it will take T-bills as payment instead of cash.

“(Draghi’s) comments are likely to keep alive the hopes that the ECB adds more stimulus measures to push the inflation expectations back upwards,” said Suvi Kosonen, an analyst at Nordea.

Bloomberg