European Government Bonds Decline on Fed QE Tapering Outlook

European government bonds fell as minutes of the Federal Reserve’s October policy meeting showed the central bank may taper its $85 billion in monthly asset purchases “in coming months” if the U.S. economy improves.

Benchmark German bund yields climbed to the highest level in more than a week as a report showed manufacturing and services output in the euro area expanded for a fifth month in November. Spanish and Italian bonds pared their declines amid speculation the European Central Bank, which this month cut its key interest rate, will add stimulus to support the recovery.

“The Fed was, of course, the big catalyst” for rising bund yields, said Jan von Gerich, a fixed-income strategist at Nordea Bank AB in Helsinki. “U.S. yields will continue to move and European yields will follow, but not to the same extent because in Europe we have a central bank that’s clearly tilted toward further easing measures.”

Germany’s 10-year bund yield climbed three basis points, or 0.03 percentage point, to 1.74 percent at 4:24 p.m. London time after rising to 1.78 percent, the most since Nov. 13. The 2 percent bond due in August 2023 fell 0.265, or 2.65 euros per 1,000-euro ($1,347) face amount, to 102.27.

U.S. policy makers “generally expected that the data would prove consistent with the committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months,” according to the record of the Federal Open Market Committee’s Oct. 29-30 gathering, released yesterday in Washington. The FOMC next meets on Dec. 17-18.

Spanish Sale

Spain’s 10-year bond yield rose two basis points to 4.11 percent after climbing to 4.16 percent, the most since Nov. 7. The rate on similar-maturity Italian debt increased one basis points to 4.10 percent.

Spain auctioned 3.5 billion euros of notes due in 2017 at an average yield of 2.101 percent today. The nation has covered 99.4 percent of its planned issuance for this year, and may use funds raised at subsequent auctions this year to redeem some bills and lengthen its average debt maturity, the Spanish Economy Ministry said in an e-mailed statement.

The extra yield, or spread, investors demand to hold Spain’s 10-year bonds instead of five-year notes widened six basis points to 150 basis points, the most since Sept. 7, 2012.

ECB officials are weighing further tools to secure the economic recovery and reduce the risk of deflation after they cut the main refinancing rate to a record-low 0.25 percent on Nov. 7.

Deposit Rate

The ECB is considering a smaller-than-normal reduction in the deposit rate if officials decide to take it negative, according to two people with knowledge of the debate. Policy makers would cut the rate for commercial lenders who park excess cash at the ECB to minus 0.1 percent from zero, said the people who asked not to be identified because the talks aren’t public.

Central bank President Mario Draghi said in a speech in Berlin today that policy makers haven’t changed their mind on a negative deposit rate since their previous meeting.

Eonia forward contracts expiring on ECB meeting days aren’t pricing in negative interest rates, Commerzbank AG strategists Alexander Aldinger and Michael Leister wrote in a note today. The yield on the rolling six-month forward contract was 0.075 percent today, up from as low as minus 0.03 percent in December.

The German 10-year yield will probably drop to 1.70 percent by the end of the year even if it rises before then, Nordea Bank’s von Gerich said. The median of economists’ and strategists’ predictions compiled by Bloomberg is for the rate to end 2013 at 1.75 percent and rise to 2.10 percent in June.

Output Expands

A composite gauge of euro-region manufacturing and services output, based on a survey of purchasing managers, was 51.5 this month from 51.9 in October, London-based Markit Economics said today. A reading above 50 indicates expansion.

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

Austrian 10-year bond yields rose two basis points to 2.10 percent.

German government bonds lost 1.2 percent this year through yesterday, according to Bloomberg World Bond Indexes. Spain’s returned 11 percent and Italy’s earned 7.3 percent.

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