April 17, 2013 5:11 pm

German borrowing cost falls to record low

Germany’s benchmark borrowing costs fell to a record low at a debt sale on Wednesday, as Europe’s government bond markets continued to confound early-year pessimism.

Berlin raised €3.35bn through the sale of 10-year bonds at a yield of just 1.28 per cent, down from 1.36 per cent at the last auction of comparable maturity bonds in March.

The borrowing costs of Germany and the eurozone’s periphery have generally moved in opposite directions since the continent’s crisis erupted in 2010, as investors fled riskier bond markets for the safety of northern Europe’s more solid members. But yields for almost all European bonds have declined this year.

Steven Major, head of fixed income research at HSBC, said: “The correlation between Spanish bonos and German Bunds has gone positive this year, challenging the idea that Bunds rally because there is tension in the periphery.”

This has defied the forecasts of many strategists. While the European Central Bank’s promise last year to keep the eurozone intact was widely expected to subdue the bond yields of the currency bloc’s weaker members such as Spain, many analysts said the bond yields of stronger members – particularly Germany – would drift higher this year.

Strategists say the surprisingly strong performance of European bond markets is almost certainly the result of a glut of liquidity flowing from central banks seeking a home, whether in Europe’s core or periphery. The Bank of Japan’s announcement of more aggressive bond buying is expected to compel many Japanese investors out of their domestic bond market and into Europe.

The drop in its bond yields could reflect perceptions that Spain is tackling its structural problems, and reduced worries about a eurozone break-up.

Despite the low returns on offer, investor demand was strong in Germany’s auction, according to strategists. “Given the backdrop of a peripheral rally and the very low yield available, this is a solid auction result,” Rabobank analysts said in a note.

“With all boats effectively rising on this liquidity tide, we would argue we are seeing not a ‘great rotation’ but a ‘great flotation’.”

Slovenia managed to sell €1.1bn of 18-month bills on Wednesday, more than twice its target.

Italy’s treasury also enjoyed a good day, as retail investors placed €17bn of orders at a domestic debt offering. That was near the record €18bn raised over four days in October. The Italian debt management office ended the sale early.

However, Portugal was forced to pay slightly more at an auction of €1.5bn of 12-month bills. Lisbon’s debt management agency paid an average yield of 1.394 per cent for the securities, compared with 1.277 per cent at an auction in February.

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