German Bonds Rise Most in Six Weeks as EU Cuts Inflation Outlook

  • European Commission cuts inflation forecast by more than half
  • Portugal's bonds hold five-day gain on DBRS's rating decision

Germany’s 10-year government bonds climbed the most in more than six weeks as the European Commission cut its inflation forecast for the euro region by more than half, bolstering speculation that the European Central Bank will increase stimulus.

Euro-region sovereign securities advanced as the Brussels-based commission also warned of slower-than-predicted growth across the 19-nation bloc. Inflation in the region will average 0.2 percent this year, the commission said Tuesday. That’s down from the 0.5 percent predicted in February.

“The lower the expected inflation, the more likely the ECB will do more -- be it on the rate front or the QE front,” said David Schnautz, a London-based rates strategist at Commerzbank AG, referring to the central bank’s asset-purchase program. “The growth outlook for the region may not be too bad, but by far not strong enough. Inflation is stubbornly low. That is supportive for European government bonds.”

Benchmark German 10-year bund yields dropped seven basis points, or 0.07 percentage point, to 0.20 percent as of 4:08 p.m. London time. That’s the steepest decline since March 17. The 0.5 percent security due in February 2026 rose 0.645, or 6.45 euros per 1,000-euro ($1,151) face amount, to 102.895.

Even as the ECB uses a mix of low or negative interest rates in addition to 80 billion euros per month in asset purchases to boost growth, inflation is expected to remain below the central bank’s goal of just under 2 percent. It will average 1.4 percent in 2017, the commission said. Slower inflation boosts the value of securities that deliver fixed-interest payments.

Inflation Outlook

Inflation is expected to remain very low “for a longer period than previously forecast,” European Economic Affairs Commissioner Pierre Moscovici told reporters in Brussels. With “gradually increasing energy prices, inflation is expected to step up in the second half of this year,” he said.

Germany’s 10-year break-even rate, a gauge of the outlook for inflation derived from the yield difference between bunds and index-linked securities, was at 1.07 percent, having closed Monday at 1.09 percent, which matched the highest since December.

Portugal’s 10-year bonds held a five-day gain after DBRS Ltd. last week maintained the nation’s investment-grade rating, securing their eligibility for the ECB’s QE program. The yield was little changed at 3.10 percent Tuesday, while that on Italian 10-year securities declined less than one basis point to 1.47 percent.

France’s 10-year bond yield dropped six basis points to 0.56 percent before the nation auctions as much as 8 billion euros of debt Wednesday, including 10-year securities.

The ECB’s asset buying has helped Germany’s bonds outperform U.S. Treasuries this year. German sovereign securities returned 3 percent through Monday, while Treasuries earned 2.8 percent, according to Bloomberg World Bond Indexes.

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