Investors sought out lower-rated eurozone bonds on Tuesday, venturing from the safety of German benchmarks and betting on action from the European Central Bank to shore up the bloc after Britain’s vote to leave the European Union.
Ten-year yields in Spain, Italy and Portugal all fell more than 8 basis points while yields on German Bunds, which hit a record low on Friday as investors sought shelter in the lowest risk assets, rose for the first time in a week.
Traders were looking to a meeting of EU leaders for more clarity on the next steps after the shock result of last Thursday’s UK referendum.
Italian Prime Minister Matteo Renzi said yesterday that Brexit could be a great opportunity for Europe and there have been signs that Brexit may provide impetus to tackle some of its long-standing problems.
But with economists forecasting the vote will lead to lower growth and inflation in the eurozone, some in markets were also expecting further action from the ECB to mitigate the impact.
The ECB’s favoured measure of markets’ long-term inflation expectations, the eurozone five-year, five-year breakeven forward rate touched a record low below 1.28%, ever further from the ECB’s inflation target of just under 2%.
Analysts said this increased the chances of more monetary stimulus from the central bank.
Money markets meanwhile fully priced in a 10 basis point cut in the ECB’s deposit rate by the end of the year.
“If we assume that the UK vote will eventually fuel lower growth, lower inflation in the eurozone, then it makes sense to expect that the ECB will deliver more and more means maybe more QE, more rate cuts,” said Patrick Jacq, Europe rate strategist at BNP Paribas.
ECB President Mario Draghi will join the EU leaders’ meeting in Brussels.
Bonds issued by the lower-rated countries on the eurozone’s southern periphery have been big beneficiaries of the ECB’s €1.74 tn quantitative easing bond-buying scheme.
Spanish 10-year yields fell 10 bps to 1.366%, its lowest since April 2015.
This followed a 15 bps fall yesterday, the biggest one-day fall in two years, after electoral gains for the centre-right People’s Party raised the prospect of an end to political deadlock.
Italian 10-year yields fell 7 bps to 1.36% but Spain’s outperformance took the gap between the two countries’ 10-year yields to its tightest since July 2015.
Renzi on Tuesday said European institutions were ready to step in to support the nation’s banks if necessary, but they did not currently need help.
A government source told Reuters yesterday Renzi would seek more flexibility from the EU regarding Italy’s public spending and rules on state aid for Italian banks, which are saddled with €360bn of bad loans.
The so-called doom loop between highly-indebted banks and sovereigns is regarded as one of the eurozone’s key vulnerabilities since its debt crisis.
Nick Stamenkovic, bond strategist at RIA Capital Markets, said Italy’s efforts to shore up its banks will have consequences for its fiscal position, which could hurt its government bonds in the future. “But we’re not going to see the type of selloff we saw in June 2012 crisis because the ECB is holding a lot of bonds on its balance sheet and can buy more if necessary,” he said.
Portuguese 10-year yields fell 10 bps to 3.22%.
German 10-year yields, which hit a record low of minus 0.169% on Friday, rose 2 bps to minus 0.09% as investors showed a tentative appetite for riskier assets.
European stocks rose for the first time in three days after cumulative falls of more than 11%.
Michael Hewson, chief markets analyst at CMC Markets expected Bund yields to stay around current levels.
“I would be very surprised in the short-to-medium term if German Bunds go back much above zero,” he said.