Bund Yield Falls to Record on Debt Crisis; Spanish Notes Slide

German 10-year bund yields dropped to a record low as speculation Europe’s debt crisis is worsening underpinned demand for the region’s safest securities.

Bunds headed for their biggest monthly gain this year and Spanish notes slid after a Spanish government spokesman said the country may need to issue more bonds to rescue the Bankia group. German government securities were also boosted as Governing Council member Ewald Nowotny said the European Central Bank wasn’t considering resuming bond purchases to stem rising borrowing costs in the euro area.

The drop in German yields “shows how sensitive risk markets are to negative news on the Spanish banking sector,” said Nick Stamenkovic, a strategist in Edinburgh at RIA Capital Markets Ltd., a broker for banks. “Continued uncertainty over the extent of the Spanish bank problem will drive investors into safe havens, pushing 10-year bund yields to new lows.”

Germany’s 10-year bund yield was little changed at 1.37 percent at 4:14 p.m. in London after falling to an all-time low 1.345 percent. The price of the 1.75 percent bond maturing in July 2022 was at 103.58. German 10-year futures climbed to an all-time high, with the contract expiring in June rising as much as 0.2 percent to 144.58.

German bonds due in more than a year returned 2.2 percent so far this month, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. That’s the most since they gained 3.1 percent in December.

Bankia Option

Spain considers using treasury bonds instead of cash to recapitalize Bankia has become an option, according to an economy ministry spokesman, who asked not to be identified by name in line with policy.

The government nationalized Bankia on May 9, leading the lender with the biggest Spanish asset base to request 19 billion euros of state backing to clean up bad loans. That’s in addition of the 4.5 billion euros of Bankia preference shares the government has already bought.

Spain’s notes fell for a third day. The two-year yield climbed 15 basis points to 4.62 percent, after rising to 4.69 percent, the highest since Dec. 12. The five-year yield gained nine basis points to 5.83 percent.

The extra yield investors demand to hold Spanish 10-year bonds instead of their German counterparts narrowed by five basis points to 507 basis points after reaching 516 basis points, the widest since the euro’s introduction in 1999.

‘Not a Matter’

Spanish Prime Minister Mariano Rajoy last week called on the ECB to buy his government’s bonds, after yields on the debt approached the level that pushed Ireland, Greece and Portugal to request international bailouts.

“This for the time being is not a matter of discussion,” Nowotny told reporters in Belgrade today, when asked if bond purchases are something the ECB is contemplating.

While the ECB has bought 212 billion euros of government debt since May 2010, it halted the program this year after injecting more than 1 trillion euros into the financial system through three-year loans.

ICAP Plc, the biggest broker of trades between dealers, is expecting clearinghouse LCH.Clearnet Ltd. to impose a margin increase on repurchase agreements secured against Spanish government bonds “at any moment.”

“We run the very real risk of a self-reinforcing blow to the financing abilities of both the Spanish financial sector and the sovereign itself,” ICAP London-based economist Don Smith wrote in a note to clients. “Prime Minister Rajoy’s claims yesterday that the country’s banks don’t need a bailout would then look very shaky indeed.”

German Inflation

Bunds also gained as a government report showed Germany’s inflation rate dropped to the lowest since January 2011, helping preserve the value of the fixed payments from debt.

German inflation, calculated using a harmonized European Union method, slowed to an annual rate of 2.1 percent in May from 2.2 percent in April, the Federal Statistics Office said. Prices fell 0.3 percent from the previous month.

Italian bonds declined as the nation sold 8.5 billion euros of six-month bills. The securities were sold at an average yield of 2.104 percent, up from 1.772 percent at the previous auction of similar-maturity debt on April 26. Investors bid for 1.61 times the amount allotted, down from 1.71 times last month.

The Italian 10-year yield rose one basis point to 5.75 percent after reaching 5.79 percent, the highest since May 22.

Switzerland sold 689 million francs ($719 million) of three-month bills at a yield of minus 0.62 percent. That compares with a rate of minus 0.20 percent at a previous auction of similar-dated securities on May 15.

To contact the reporters on this story: David Goodman in London at dgoodman28@bloomberg.net; Keith Jenkins in London at kjenkins3@bloomberg.net

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

Bloomberg reserves the right to edit or remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.