Inflation Market Buoys Euro Bonds While Making ECB Move Remote

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As investors debate which month the Federal Reserve will raise U.S. interest rates for the first time since 2006, in Europe they’re far from picking dates. The chances of monetary tightening are remote, inflation gauges show.

Five-year inflation swaps fell below 1 percent this week for the first time since early April, indicating no pressure on the European Central Bank to curb its bond-buying program. The drop, owing partly to China’s market rout and lower oil prices, is good news for holders of the region’s bonds, which are returning more than their U.S. peers. Even with China’s market turmoil hurting higher-yielding investments, Spanish and Italian bonds outperformed Treasuries in the past week.

“Inflation is not directly a problem in Europe -- to the contrary” it’s diminishing, said Piet Lammens, head of research at KBC Bank NV in Brussels. “With lower oil prices, that is a headwind for higher yields. For the moment for Europe, the upside is protected by this low inflation.”

Yields on Germany’s 10-year bonds on Wednesday remained below their average close last week. They increased two basis points, or 0.02 percentage point, to 0.71 percent as of 4:35 p.m. London time. The 1 percent security due in August 2025 fell 0.225 or 2.25 euros per 1,000-euro ($1,107) face amount, to 102.78.

The yield reached 0.67 percent on Monday, the lowest since July 8, as the Shanghai Composite Index tumbled the most since 2007.

Fed Meeting

European bonds declined on Wednesday with their U.S. peers before the Fed’s latest monetary-policy decision. While all economists surveyed by Bloomberg forecast the central bank will keep interest rates close to zero, they’ll be looking for hints on future decisions in the accompanying statement. The Treasury 10-year yield increased four basis points to 2.29 percent.

In Europe, five-year inflation swap rates, a market gauge of price-growth expectations over that period, slipped to 0.971 percent on Tuesday, the least since April 1.

Even lower is Germany’s five-year break-even rate, which also anticipates consumer-price growth in that time frame. It’s at about at 0.58 percentage point. The ECB’s inflation target is just below 2 percent.

German bunds returned 0.6 percent in the past week through Tuesday, compared with gains of 0.7 percent for Italian securities and 0.6 percent for Spanish debt, according to Bloomberg World Bond Indexes. They all beat Treasuries, which made 0.5 percent.

The yield on Spanish 10-year bonds rose five basis points to 1.96 percent, in line with the average closing price last week. Yields on similar-maturity Italian bonds rose three basis points to 1.91 percent.

(An earlier version of this story was corrected for a percentage-point expression in fourth paragraph.)

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