German Notes Decline for Second Week on Euro-Area Growth Signs

Germany’s two-year notes fell for a second week before industry reports next week that economists said will show euro-area services and manufacturing expanded in December, damping demand for safer assets.

Ten-year bund yields were six basis points from the highest level since October as investors weighed the prospect of the Federal Reserve cutting asset-purchase stimulus as soon as this month’s meeting. The extra yield on two-year Treasuries over German notes was eight basis points after shrinking to seven basis points yesterday, the least since February based on closing prices. Spain’s bonds gained for a second week as its lenders reduced borrowing from the European Central Bank.

“The market is dominated by speculation about what the Fed will do with its bond-buying program next week and that affected yields in Europe as well,” said Jussi Hiljanen, head of fixed-income research at SEB AB in Stockholm. “Some euro-region data next week may show improvement but our view remains that the overall recovery is uneven. Any tightening in spreads between German bonds and Treasuries is likely to be temporary.”

Germany’s two-year yield climbed three basis points, or 0.03 percentage point, this week to 0.25 percent at the 5 p.m. close in London. The zero percent note due in December 2015 fell 0.055, or 55 euro cents per 1,000-euro face amount, to 99.515. They were little changed today.

The 10-year bund yield was little changed this week at 1.83 percent after rising to 1.89 percent on Dec. 6, the highest level since Oct. 17.

Services, Manufacturing

A gauge of euro-area services rose to 51.4 from 51.2 in November, according to a Bloomberg News survey before Markit Economics releases the data on Dec. 16. An index of manufacturing climbed to 51.8 from 51.6, a separate survey showed before the report the same day. A reading above 50 indicates expansion.

The ECB is ready to act again after policy makers unexpectedly cut the official interest rate to a record 0.25 percent in November, Governing Council member Ardo Hansson said at a conference today in Tallinn, Estonia.

ECB Executive Board member Benoit Coeure said in Paris a “major challenge” was to prevent “bad deleveraging” when banks cut holdings of higher-quality assets and the process turns into a search for yield.

Spain’s bonds headed for their first weekly gain in a month as the central bank said the country’s lenders cut their borrowing from the ECB to 220.5 billion euros in November from 234.8 billion euros in the previous month.

Spanish 10-year yields fell seven basis points this week to 4.10 percent. Italy’s 10-year yield dropped nine basis points since Dec. 6 to 4.09 percent.

Fed Minutes

Fed policy makers next meet on Dec. 17-18. Minutes of their Oct. 29-30 gathering released on Nov. 20 showed they expected economic data to indicate improvement in the labor market and “warrant trimming the pace of purchases in coming months.”

The ECB said banks plan to repay 22.7 billion euros in three-year loans next week compared with 7.07 billion euro this week. That would be the largest amount since February. The increase is driven partly by the fact that next week would be the last repayment this year of longer-term refinancing operation loans, provided by the central bank to revive growth.

A gauge of the cost for banks to borrow from each other overnight in euros was near a two-week high. Eonia, or the euro overnight index average, was fixed at 0.139 percent yesterday after rising to 0.144 percent on Dec. 11, the highest level since Nov. 29.

“The surge in three-year LTRO repayment raises the question of how long the ECB will tolerate this passive money-market tightening,” said Christoph Rieger, head of interest-rate strategy at Commerzbank AG in Frankfurt. “It is questionable whether it sees the urgency to act. The increase in money-market rates could be seen as part of a normalization process.”

German bonds handed investors a loss of 1.8 percent this year through yesterday, the worst performer of 15 euro-area debt markets tracked by Bloomberg World Bond Indexes. Spain’s returned 11 percent and Italy’s rose 7.5 percent.

Before it's here, it's on the Bloomberg Terminal.