March 14, 2018 / 12:35 PM / 3 days ago

UPDATE 2-Trade war threat drives demand for high-grade euro zone bonds

* Long-term market gauge of inflation drops below 1.70 pct

* German 10-year yields falls to 1 1/2 month low

* Dutch govt bond auctions swamped with demand

* Euro zone periphery govt bond yields (Updates prices)

By Abhinav Ramnarayan and Fanny Potkin

LONDON, March 14 (Reuters) - Germany’s 10-year government bond yield fell to a 1-1/2 month low on Wednesday, while Italian borrowing costs rose, as the spectre of trade wars cast doubt over the global recovery and the removal of the European Central Bank’s stimulus.

U.S. President Donald Trump’s decision on Tuesday to sack Secretary of State Rex Tillerson, seen as a strong supporter of free trade, was followed by sources telling Reuters the United States was seeking to impose tariffs on up to $60 billion of Chinese imports.

ECB chief Mario Draghi meanwhile said on Wednesday that the possible spillovers of the new trade measures announced by the U.S. administration could hurt inflation.

Draghi, along with ECB chief economist Peter Praet, took pains to temper market expectations for a speedy exit from bond buying.

Both policymakers argued the ECB needed further evidence that inflation was rising towards its target and would end asset buys only when it was satisfied that price growth was on a sustained path towards its objective.

A market gauge of long-term inflation expectations that is closely watched by the ECB, the five-year five-year breakeven forward swap, fell below 1.70 percent.

“The bigger picture is we are currently seeing an environment of falling yields, and one of the key reasons is fears of an international trade war,” said DZ Bank analyst Sebastian Fellechner.

German 10-year government bond yields fell to a 1-1/2 month low of 0.583 percent, as the demand for safe haven assets intensified.

Most euro zone bond yields were down 2-3 basis points on the day, as were 10-year U.S. Treasury yields, which fell 4.4 basis points.

Italian bond yields, however, jumped after the leader of the anti-establishment 5-Star Movement said he was open to forming any sort of coalition government as long as it did not include the Democratic Party, which has ruled for the past five years.

Italy’s 10-year bond yield rose as high as 2.03 percent , up 5 basis points on the day after the comments by the League’s leader, Matteo Salvini.

Elsewhere, demand for a Dutch auction of 10-year bonds hit 18 billion euros at one stage, a strong result for the Netherlands debt agency. (

The yield on Germany’s 30-year bonds inched down 2 bps to 1.24 percent, after having risen 8 basis points due to disappointing auction results.

The German Finance Agency sold only 1.211 billion euros in a top-up of its 30-year Bund on Wednesday, falling short of its aim to raise 1.5 billion euros for the bloc’s largest economy.

Portugal sold all 1.25 billion euros ($1.55 billion) of 10- and 27-year bonds on offer in an auction on Wednesday, with benchmark 10-year bond borrowing costs hitting an all-time low in a regular auction of 1.778 percent.

Reporting by Abhinav Ramnarayan Editing by Alison Williams

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