June 9, 2017 / 7:32 AM / 9 months ago

UPDATE 1-UK election shock pins euro zone bond yields near multi-month lows

(Updates throughout)

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Dhara Ranasinghe

LONDON, June 9 (Reuters) - Euro zone government bond yields dipped on Friday as Britain’s ruling party lost its majority in parliament just days before talks on the country’s exit from the European Union are due to start, triggering support for safe-haven assets.

German Bund yields were pinned near six-week lows, having already tumbled in recent weeks on the possibility of an election upset as polls suggested a tightening race between Britain’s leading parties.

No clear winner emerged from Thursday’s British election.

With talks of unprecedented complexity on Britain’s departure from the EU to start in just 10 days’ time, sterling was hit by uncertainty over who would form the next government and over the fundamental direction Brexit would take.

Across the euro area, government bond yields opened slightly lower, with French 10-year bonds yields touching a fresh five-month low at around 0.63 percent.

Italian yields extended the previous day’s sharp falls to hit a 1-1/2 week low at 2.14 percent.

Germany’s benchmark 10-year bond yield edged lower to 0.25 percent and was within sight of six-week lows hit the previous session after the European Central Bank cut its forecasts for inflation and said policymakers had not discussed scaling back its massive bond-buying programme.

“A flight-to-safety was already visible running into the election and other key risk events this week,” said Martin van Vliet, a senior rates strategist at ING.

Prime Minister Theresa May unexpectedly called the snap election seven weeks ago, even though no vote was due until 2020. At that point, polls predicted she would massively increase the slim majority she had inherited from predecessor David Cameron.

Instead, she risks an ignominious exit after just 11 months at Number 10 Downing Street, which would be the shortest tenure of any prime minister for almost a century.

Political turmoil in Britain is the worst-case scenario for EU leaders who want to press ahead quickly with Brexit talks. These are due to start on June 19 but now could be delayed - narrowing the window of time available to clinch a deal before a March 2019 deadline.

Any expectations that a softer Brexit stance and fiscal expansion could arise from the election could renew global reflation trades and push bond yields up, analysts said.

“If forecasts solidify into reality then, on realisation of a softer Brexit stance and more fiscally easy outlook, the market should be factoring in greater growth and inflation and gilt supply, generating a steeper gilt curve and stronger GBP,” said Peter Chatwell, head of euro rates strategy at Mizuho.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets

Reporting by Dhara Ranasinghe; editing by Jason Neely

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