European bonds set to be aided by ECB

BENCHMARKS::Analysts forecast a strong start to the year with EU investor demands for bonds expected to be strong, which could support another ECB deposit rate cut


Sun, Jan 03, 2016 - Page 13

European government bonds are set to start this year supported by the resumption of the central bank’s asset-purchase program and a decline in sovereign issuance.

After a year in which the European Central Bank (ECB) attempted to bolster inflation through its 60 billion euro (US$65 billion) a month bond-buying plan, the first major economic report of this year is likely to show that consumer-price growth remains a fraction of the central bank’s goal.

Investor demand for bonds could also be underpinned by Germany paying around 23 billion euros of redemptions due tomorrow, the same day as ECB bond purchases, which were halted on Dec. 21 before the holiday period, resume.

The data, due on Tuesday, is expected to show annual inflation in the currency bloc accelerated to 0.4 percent last month, the median forecast of economists in a Bloomberg survey said.

While that is up from 0.2 percent in November, it is still short of the ECB’s desired rate of just under 2 percent. At their latest policy meeting on Dec. 3, officials cut the deposit rate to minus-0.3 percent and extended the central bank’s quantitative-easing plan by at least six months.

“Most European events will favor a bond-positive start to the year and we will probably get that,” Helsinki’s Nordea Bank AB chief strategist Jan Von Gerich said.

“The ECB in terms of further easing has very much left the door open and at the very least they will cut the deposit rate once again. If you look at the dynamics in terms of supply and demand, you have most countries seeing lower issuance and at the same time you have the ECB buying,” Von Gerich said.

Benchmark German 10-year bunds yielded 0.63 percent as of the 5pm London close on Wednesday last week, the final trading day last year. The price of the 1 percent security due in August 2025 was 103.45 percent of face value. The bund yield rose from 0.54 percent in December 2014. Last year it reached a record low of 0.049 percent in April and climbed to its peak of 1.06 percent two months later.

Italian 10-year bond yields ended the year at 1.60 percent, down from 1.88 percent at the end of 2014. They touched a record-low 1.031 percent in March, the month the ECB started its asset purchases. Similar-maturity Spanish yields closed last year at 1.77 percent, up from 1.61 percent in December 2014 and a record-low 1.048 percent in March.

Euro-area sovereign securities returned 1.70 percent last year, Bloomberg World Bond Indexes said, adding to a gain of 13 percent in 2014. They outperformed US peers, which made 0.7 percent last year and UK gilts, which earned 0.2 percent.

International sovereign-debt markets were dominated last year by the ECB’s unprecedented bond-purchase program and the US Federal Reserve’s decision to raise interest rates for the first time in almost a decade.

This year the possibility of a referendum on Britain’s EU membership is likely to capture investors’ attention, though the uncertainty around the vote might be a risk to UK assets.

The UK benchmark 10-year gilt yields climbed from a record low set in January last year. The Bank of England (BOE) held interest rates at an all-time low throughout the year despite signals at times that an increase was approaching sooner than the market was pricing. With UK economic growth slowing, markets have not fully priced a move by the BOE until the end of this year.

“Gilts have been a bit of a sideshow,” said Azim Meghji, the London-based head of UK fixed income at Santander Asset Management, which manages the equivalent of US$170 billion.

“The focus for most investors has been what the ECB are going to do and what the [US] Fed will do and those have been two competing themes throughout 2015, which has left gilts at the mercy of where the broad market for government bonds has gone,” Meghji said.

The benchmark 10-year gilt yielded 1.96 percent as of 1pm close on Friday in London. The yield dropped to a record-low 1.325 percent on Jan. 30, last year and peaked at 2.21 percent in June.

With UK inflation near zero and the outlook for international growth remaining shaky, BOE officials have less incentive to raise interest rates. Recent data showed wage growth, a key focus of deciding monetary policy, had slowed and so policymakers can remain cautious for the time being, Meghji said.

“After 2014 being a blockbuster year, 2015 being a mediocre year, I wouldn’t expect 2016 to be significantly different at this stage than the year we just had,” Meghji said.