European Bonds Slump as Draghi Signals No More Rate Cuts

Euro-area government bonds slumped after the European Central Bank upgraded its forecasts for euro-area growth and President Mario Draghi signaled no further intention to push down borrowing interest rates.

German 10-year bund yields rose to the highest in almost seven weeks after data showed the U.S. economy grew more than initially reported in the third quarter, damping demand for fixed-income assets. The ECB left its benchmark interest rate at a record-low 0.25 percent and now forecasts the economy will contract 0.4 percent this year, before expanding 1.1 percent in 2014. Italian 10-year yields jumped the most in two months, while Spanish yields increased to the highest since October.

“Draghi’s opening statement leaves room for further policy action over the medium term, but it does not signal imminent action,” said Lyn Graham-Taylor, a fixed-income strategist at Rabobank International in London. “We’re seeing a selloff in core government bonds.”

Germany’s 10-year yield increased five basis points, or 0.05 percentage point, to 1.86 percent at 4:46 p.m. London time after reaching 1.87 percent, the highest since Oct. 18. The 2 percent bund maturing in August 2023 fell 0.4, or 4 euros per 1,000-euro ($1,367) face amount, to 101.23. Two-year note yields rose four basis points to 0.20 percent.

Draghi said at a press conference that while the ECB was technically ready’’ to cut its deposit rate below zero, the Governing Council only discussed a negative rate “briefly” at its meeting. The deposit rate is what the ECB charges banks for parking excess cash at the central bank. It is set at zero.

ECB Forecasts

The ECB unexpectedly cut its main refinancing rate last month after euro-area inflation fell to a four-year low. Previously, it forecast inflation of 1.5 percent this year and 1.3 percent in 2014, with the economy contracting 0.4 percent and growing 1 percent, respectively. It predicts 1.5 percent growth in 2015.

The absence of further ECB measures is bearish for bonds, according to Harvinder Sian, a fixed-income strategist at Royal Bank of Scotland Group Plc in London.

“There are no new liquidity measures and the GDP projection at 1.5 percent for 2015 is punchy and perhaps above trend,” Sian wrote in an e-mailed note. “The inflation forecasts underline only a temporary dip. There is no smoking gun for more ECB activism and so froth in the market has to come off.”

Five-year notes underperformed their two- and 10-year equivalents. The securities were seen as a “sweet spot” for investors expecting further easing measures by the ECB, according to Rabobank’s Graham-Taylor.

Yield Spread

The additional yield investors demand to hold Germany’s five-year notes over two-year debt rose two basis points to 61 basis points. The yield spread between five- and 10-year securities narrowed two basis points to 104 basis points.

Federal Reserve officials have signaled they may taper $85 billion of monthly asset purchases “in coming months” if the economy improves as anticipated. Policy makers are due to meet next on Dec. 17-18.

U.S. gross domestic product climbed at a 3.6 percent annualized rate, from an initial estimate of 2.8 percent, the Commerce Department said. A separate report showed first-time claims for jobless benefits dropped 23,000 to 298,000 last week.

Benchmark U.S. 10-year yields rose as much as four basis points to 2.87 percent, the highest since Sept. 18.

Spanish 10-year yields increased seven basis points to 4.25 percent after rising to 4.28 percent, the highest since Oct. 21. The rate on similar-maturity Italian bonds climbed eight basis points to 4.24 percent, the biggest increase since Sept. 27.

Volatility on Austrian bonds was the highest in the euro-area today, followed by those of Italy and France, according to measures of 10-year debt, the yield spread between two- and 10-year securities and credit-default swaps.

Germany’s bonds lost 1.6 percent this year through yesterday, the worst performer among 15 euro-area sovereign-debt markets tracked by Bloomberg World Bond Indexes.

To contact the reporters on this story: Neal Armstrong in London at narmstrong8@bloomberg.net; Lucy Meakin in London at lmeakin1@bloomberg.net

To contact the editor responsible for this story: Paul Dobson at pdobson2@bloomberg.net

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