Euro zone yields fall to new lows on signs of monetary easing

Euro zone government bond yields hit new lows today after European Central Bank president Mario Draghi sent his clearest signal yet that the bank could ease monetary policy next month.

After the bank left rates on hold at its monthly policy meeting, Mr Draghi said that policymakers were “comfortable with acting next time” to boost the euro zone economy if price inflation forecasts warrant it.

The prospect of imminent new ECB stimulus measures gave fresh impetus for investors to keep scooping up lower-rated euro zone bonds which offer relatively higher returns than core debt.

Spanish and Italian 10-year bond yields hit the latest in a series of record lows, dropping 7 basis points on the day to 2.90 per cent and 2.94 per cent respectively while Portuguese equivalents at eight-year lows.

German 10-year Bund yields, the benchmark for euro zone borrowing, fell 3 basis points to 1.45 per cent, taking them to a whisker from 11-year lows plumbed this week.

Money market rates also fell as Mr Draghi’s comments bolstered bets that the bank would act next month, when it has new euro zone inflation and growth forecasts before meeting.

"He (Draghi) explicitly talked about June, which was a more tangible hint than we've had. This was the trigger for the market to rally," said Commerzbank strategist David Schnautz.

“The ECB is reinforcing the underlying trend again of spread tightening, of investors getting pushed down the credit curve and up the maturity curve.

The trend in lower yields has been supported this year by expectations the ECB will eventually act to tackle low inflation. That might include asset purchases, though many in the market say that would be the bank’s last resort.

Such expectations helped Spain raise more than targeted and Ireland secure record-low borrowing costs at debt sales today.

“We’re in a yield grab-athon,” said Grant Peterkin, head of absolute bond returns at Lombard Odier. “Investors have given up on the safety aspect ... in search for that yield.”

Increased volatility in money markets and dwindling spare cash in the banking system have helped to make ECB action more likely. So has a steadily strengthening euro, which threatens the region’s recovery.

Mr Draghi was sanguine about recent money market fluctuations, although he has said “unwarranted” gains in money market rates could lead to looser monetary policy. He has not specified how high rates would have to rise to trigger action by the ECB.

Investors expect the central bank to cut its main refinancing rate and start charging banks for parking cash with it overnight - slashing its overnight deposit rate below zero per cent - to force them to lend to the broader economy.

It was also expected to suspend its weekly deposit tenders, through which it drains money from the banking system to neutralise the effect of the bond purchases it made at the height of the euro zone debt crisis.

Such a move would release €167.5 billion into the banking system, a sum equal to the outstanding amount of bonds the ECB bought under its defunct Securities Markets Programme, which would subdue money market rates.

"One of the reasons the ECB did not move today may well be that they do not want empty-gesture policy moves like just cutting the refi. That in turn puts negative rates and QE/CE (credit easing) on the table," RBS strategists said in a note. (Reuters)