German Notes Drop After Ifo Report as Italy Yield Spread Narrows

Germany’s notes fell, with two-year yields rising the most in 11 weeks, as the nation’s business confidence climbed to the highest level in more than a year in November, damping demand for the safest assets.

The extra yield investors demand to hold Italy’s 10-year bonds over benchmark German securities narrowed after the Rome-based Treasury yesterday canceled debt auctions planned for Nov. 26 and Dec. 12, citing reduced funding needs. The yield on Spain’s five-year notes dropped to the least relative to 10-year securities since September 2012 on bets the European Central Bank will keep its interest rates lower for longer.

“It’s just the normal reaction in the bund following a stronger economic number,” said Mathias Van Der Jeugt, a fixed-income strategist at KBC Bank NV in Brussels. “There is a little bit of upside left.”

Germany’s two-year rate climbed four basis points, or 0.04 percentage point, to 0.14 percent as of 5 p.m. London time, the biggest increase since Sept. 5. The zero percent note due in December 2015 dropped 0.07, or 70 euro cents per 1,000-euro ($1,355) face amount, to 99.725. Ten-year bund yields were little changed at 1.75 percent after climbing to 1.78 percent yesterday, the most since Nov. 13.

The Ifo institute’s business climate index, based on a survey of 7,000 executives, increased to 109.3 from 107.4 in October, exceeding the 107.7 median estimate of 43 economists in a Bloomberg survey. That’s the highest since April 2012. German gross domestic product rose 0.3 percent in the third quarter, the Federal Statistics Office in Wiesbaden said today, confirming a Nov. 14 estimate.

Italian Sale

Italy canceled the scheduled auctions after selling 22.3 billion euros of inflation-linked bonds due in November 2017 to retail investors earlier this month, the biggest-ever sale by a European government.

“If Italy has less supply coming to the market, then in the short term that is a slight positive,” said Allan von Mehren, chief analyst at Danske Bank A/S in Copenhagen. “Italy is pretty well supported by a search for yield. As the economy improves people will be willing to continue to buy Italy and Spain.”

The yield on Italy’s 10-year bond fell two basis points to 4.08 percent, narrowing the spread by three basis points to similar-maturity German bunds to 233 basis points.

The rate on Spain’s 10-year securities was little changed at 4.10 percent, leaving the spread over German bunds one basis point tighter at 236 basis points.

Yield Spread

The Spanish-German spread also shrank after Spain’s Economy Ministry said it had covered 99.4 percent of planned sales for this year and may use funds from subsequent auctions in 2013 to redeem bills.

The extra yield investors demand to hold Spain’s 10-year bonds instead of five-year notes widened five basis points to 155 basis points, the most since September 2012.

European 10-year yields are rising quicker than five-year rates after the ECB unexpectedly cut borrowing costs to a record-low 0.25 percent this month.

‘Less Attractive’

The ECB pushed “the beginning of a possible tightening cycle further out,” said Gianluca Ziglio, executive director of fixed-income research at Sunrise Brokers LLP in London. “While rates will almost certainly remain as low as they are for another 1 1/2 to 2 years, I think it is a bit of a hazard to project that so much further out. I think the market has over-reacted and the five-year has become to me less attractive than longer maturities at these levels.”

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

German government bonds lost 1.3 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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