August 6, 2019 / 11:03 AM / 4 months ago

UPDATE 2-Euro zone bond yields sink further as trade war steps up a gear

* German Bund yield hits fresh record lows

* U.S.-China trade spat remains in focus

* Brighter German data fails to dent bond rally

* Euro zone periphery govt bond yields (Updates prices, adds chart)

By Dhara Ranasinghe and Virginia Furness

LONDON, Aug 6 (Reuters) - Euro zone government bond yields fell to fresh record lows on Tuesday, due to rising concern about a global trade war after the United States branded China a currency manipulator.

A year-long U.S.-China trade war boiled over on Monday as Washington accused Beijing of manipulating its currency after China let the yuan drop to its lowest point in more than a decade.

The latest developments have exacerbated concern about the global economic outlook and reinforced expectations for rate cuts and further stimulus measures from major central banks.

German, Dutch and Austrian 10-year bond yields all hit fresh record lows. Other euro zone bond yields, down 2-3 basis points on the day, kept recent lows in sight .

“The assumption has to be that growth is going to be slowing globally, and now we have the additional risk that the trade war morphs into a currency war especially if the Chinese currency continues to depreciate,” said Chris Scicluna, head of economic research at Daiwa Capital Markets in London.

Even data showing German industrial orders rose more than expected in June failed to dent the bond market rally, while growing concern about a no-deal Brexit fuelled demand for safe-haven bonds.

The European Commission hopes to avoid Britain leaving the European Union without a deal on their future relations in place, but was prepared for such an outcome, an EC spokeswoman said on Tuesday.

Germany’s 2-year bond yield hit minus 0.82% — its lowest level since May 2018 when a rout in Italy’s bond market sparked a dash for safe-haven assets.

On Monday, Dutch 30-year and Irish 10-year government bond yields turned negative for the first time.

The fall in 10-year U.S. Treasury yields to their lowest since 2016 has pushed the gap over German Bund yields to around 227 bps — close to their tightest in about 1-1/2 years.

Analysts say the trade war escalation increases pressure on the U.S. Federal Reserve to ease monetary policy. The Fed cut U.S. interest rates last week as insurance against the effects of “simmering” trade tensions.

Interest rate futures now show traders see nearly a 40% chance the Fed will cut rates half a percentage point next month, up from less than 2% on Friday and 30% on Monday.

Markets also price in a 10 bps rate cut from the European Central Bank at its September meeting.

HSBC said on Tuesday it has cut its year-end forecasts for U.S. and German bond yields, expecting the 10-year Bund yield to fall to minus 0.8% from a previous forecast of minus 0.2%.

Elsewhere, Italy’s bond yields fell 4-5 bps after the government won a confidence vote in the Senate on Monday, prolonging its tenure. It would have had to resign had it lost the motion.

Reporting by Dhara Ranasinghe and Virginia Furness; Editing by Alison Williams and Hugh Lawson

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