European Bonds Drop as Investors Assess ECB’s Options

Euro-area bonds declined, with German 10-year yields rising for a fourth day, as investors considered whether European Central Bank policy makers will introduce unconventional easing measures this week.

French bonds slid with Irish and Belgian securities. They’re retreating after bets the central bank will cut interest rates and pursue additional measures on June 5 pushed yields on government debt across the region to a record-low last week, based on Bank of America Merrill Lynch indexes. A measure of German inflation expectations was five basis points from the lowest in two years as data today showed euro-area consumer-price gains slowed more than economists forecast in May.

“What we’re seeing is a reflection that expectations for Thursday’s meeting are quite high and the market is already pricing in some room for disappointment,” said Michael Leister, a senior fixed-income strategist at Commerzbank AG in London. “The rate side of things is pretty clear but there is a decent amount of uncertainty about what will come on top of that. There’s probably some sobering up going on now.”

The yield on benchmark German 10-year bunds increased four basis points, or 0.04 percentage point, to 1.41 percent at 4:28 p.m. London time. The rate had risen three basis points in the previous three days. The 1.5 percent security due in May 2024 fell 0.365, or 3.65 euros per 1,000-euro ($1,363) face amount, to 100.84.

ECB Predictions

A surge in euro-area sovereign bonds generated returns of more than 6 percent this year, according to Bloomberg World Bond Indexes. The gains helped Greece, the best performer, to sell bonds in April for the first time since 2010 and pushed borrowing costs to record lows from Ireland to Italy. While the rally began with investors moving back into markets they shunned during the region’s four-year debt crisis, it extended on bets the ECB will take more steps to lower interest rates.

ECB President Mario Draghi said in Portugal last week that policy makers need to be “particularly watchful” of low inflation. All but two of 60 economists surveyed by Bloomberg forecast policy makers will cut the benchmark rate from a record-low 0.25 percent on Thursday. The ECB will also lower its deposit rate below zero, according to most analysts in a separate survey.

Euro-region inflation fell to 0.5 percent from 0.7 percent in April, the European Union’s statistics office in Luxembourg said. The median forecast in a Bloomberg News survey of economists was for a decline to 0.6 percent. The rate has been less than half the ECB’s target for eight months.

Yield Forecast

“The ECB’s low-inflation fears are likely to be raised by today’s CPI data,” Steve Barrow, the head of Group-of-10 research at Standard Bank Plc in London, wrote in an investor report before the consumer-price index was released. “Bond yields in the euro zone have much further to fall even if some countries have already started to see record-low yields.”

Barrow predicts the 10-year German rate will drop below its 1.127 percent record low and reach 1 percent, with “yields in other countries in the region falling in tandem.”

The rate on 10-year Irish bonds rose two basis points to 2.60 percent, while the yield on similar-maturity French bonds climbed four basis points to 1.81 percent.

Belgium’s 10-year rate increased four basis points to 1.94 percent, while Spain’s 10-year yield was little changed at 2.85 percent after earlier dropping as much as four basis points.

Germany’s 10-year break-even rate, a measure of inflation expectations derived from the difference in yield between conventional and index-linked securities was at 1.35 percentage points. The rate fell to 1.30 percentage points in February, the lowest since May 2012, based on closing prices.

The average yield to maturity on euro-area bonds fell to 1.4271 percent on May 28, and was at 1.4497 percent yesterday, according to the Bank of America Merrill Lynch Euro Government Index.

German securities gained 4.1 percent this year through yesterday, according to the Bloomberg World Bond Indexes. Spanish bonds returned 8.3 percent and Italy’s earned 7.5 percent.

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