European government bond traders counting on the European Central Bank to boost stimulus pushed German two-year note yields to a record low this week. Even so, the volatility on the securities suggests investors are divided about how much easing is coming.
Germany’s two-year yields fell the most since Jan. 29 on Thursday, only to climb by the most since December the following day. Expectations from bank strategists about what the ECB can deliver via its policy decision on March 10, from interest-rate cuts to increased bond purchases, are running high.
Reports this week, including euro-area services and manufacturing output, added to evidence that the economic recovery is losing momentum. Even so, bonds fell Friday as traders expressed caution, with a bond-market gauge of inflation expectations climbing from a record low.
Mizuho International Plc forecasts the ECB will cut the deposit rate by 10 basis points to minus 0.4 percent next week, which is less than some investors are hoping for. Though this may cause short-dated securities to decline, the disappointment will be offset by a larger-than-expected 30 billion-euro increase in the asset-purchase program, and a clear signal that the rate on long-term loans to banks will likely be cut, according to Peter Chatwell, head of rates strategy at Mizuho in London.
“We think this is what needs to be delivered, otherwise inflation expectations will continue to de-anchor,” he said.
Germany’s two-year note yields increased less than one basis point, or 0.01 percentage point, this week to minus 0.54 percent as of the 5 p.m. London close Friday, after falling to minus 0.586 percent, the lowest since Bloomberg began collecting the data in 1990. The zero percent security due in March 2018 fell 0.025, or 25 euro cents per 1,000-euro ($1,100) face amount, to 101.10.
A negative yield means investors who purchase the securities now and hold them to maturity pay for the privilege of lending to the government.
Benchmark 10-year bunds fell for the first time in seven weeks as some traders expressed caution on how much the ECB could deliver. The yield climbed nine basis points to 0.24 percent. It dropped to 0.10 percent on Feb. 29, the lowest since April. Market News reported Friday that there’s no consensus among central bankers to add stimulus.
Italian and Spanish bonds outperformed their German peers for a third week, with the 10-year yield difference between the securities narrowing.
ECB Executive Board Member Benoit Coeure said March 2 that while officials were watching the impact of negative interest rates on banks and their profitability, the ultra-low levels are justified by sluggish growth and inflation. Governor Mario Draghi said a day earlier that euro-area inflation dynamics continue to be weaker than expected and that the technical conditions would be in place to make policy options available for implementation, if needed, for next week’s meeting.
The five-year, five-year forward inflation-swap rate, which gauges price-growth expectations and Draghi has cited to justify monetary easing, climbed 12 basis points this week to 1.50 percent, having closed at 1.36 percent on Feb. 29, the lowest on record.
The market is “somewhat more cautious,” said Jan Von Gerich, chief strategist at Nordea Bank AB in Helsinki. “I am also more convinced the ECB can deliver this time. The reaction will be towards lower yields in response to the ECB’s message, but we will probably not see any huge rallies.”