October 16, 2019 / 3:36 PM / 2 months ago

UPDATE 2-German government bond yields hit 11-week high on Brexit optimism

* Bund yields hit their highest level since end of July

* Brexit outcome could be known later on Wednesday

* Euro zone government bonds ignore trade tensions, weak U.S. retail data (Rewrites throughout, adds latest Brexit news, analyst comment)

By Yoruk Bahceli and Olga Cotaga

LONDON, Oct 16 (Reuters) - German government bond yields hit their highest level since the end of July on Wednesday as Britain and the European Union appeared closer to a Brexit deal, denting demand for safe-haven assets.

German government bond yields spiked to an 11-week high, extending a sell-off that began on Tuesday on news reports that British and EU negotiators were close to a draft deal, which boosted investors’ appetite for riskier assets.

A reporter for Irish broadcaster RTE said the main stumbling block to a Brexit deal had been removed, citing EU sources.

The Northern Irish Democratic Unionist Party, which props up the ruling Conservative Party in the UK parliament, accepted the latest proposals for a Brexit deal, according to the reporter.

European Council President Donald Tusk said at 1325 GMT that it should be known in seven or eight hours when Brexit could happen.

Germany’s 10-year yield was up 4 basis points at -0.39%, its highest since the end of July.

The market “remains volatile with headlines, positive and negative ones”, said KBC rates strategist Mathias van der Jeugt.

“The one thing you can clearly say is that during (Boris) Johnson’s brief tenure as (British) prime minister, he’s never been closer to a Brexit deal than he is right now.”

Losses on euro zone government bonds exceeded those on British government bonds, which tend to be more reactive to Brexit news. Britain’s 10-year yield was flat on the day .

“For gilts the outlook is a bit more complicated as you have to take into account what that means for the Bank of England as the policy outlook is different than the euro zone,” said ING senior rates strategist Benjamin Schroeder.

With its base rate at 0.75%, the Bank of England has more room to cut rates in a downturn than the ECB.

A sharper sell-off could take place if a Brexit deal is agreed, and 10-year Bund yields could move up an additional 20 to 25 bps, KBC’s van der Jeugt said, pushing them closer to positive territory.

The boost in risk appetite pushed the gap between Italy and Germany’s 10-year bond yields - a key gauge of risk appetite given the relative riskiness of Italian debt - to its tightest level in nearly a month at 140 bps.

Italy’s government approved a draft 2020 budget that cuts taxes for middle-earners and aims to crack down on tax evaders, while holding the deficit at the same level as this year.

Risk appetite was not dented by a fall in U.S. retail sales for the first time in seven months in September, which could raise fears that manufacturing-led weakness is spreading to the broader U.S. economy.

The market also overlooked the U.S. House of Representatives’ adoption of four pieces of legislation against China, at a time when the two sides are in talks to resolve a bruising trade war.

Analysts said the reaction of euro zone government bonds to such news showed that Brexit was what has really been driving the market.

“In Europe we focus more on the Brexit issue because it is more imminent,” said Christian Lenk, a rates strategist at DZ Bank.

Reporting by Yoruk Bahceli and Olga Cotaga; Editing by Catherine Evans, Hugh Lawson and Alex Richardson

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