German one-year yields turn negative

German one-year bond yields turned negative for the first time on record, as investors sought the short-term debts of arguably Europe’s “safest” haven amid fears the world’s largest currency bloc could unravel.

Equity markets and other risky assets rallied thanks to co-ordinated action by major central banks across the world to ease bank access to dollar funding, and China’s decision to ease monetary policy. But many investors remain cautious, arguing that the eurozone’s fundamental problems - wilting economies and the periphery’s sovereign debt woes - need more decisive policy action to be solved.

”We have become used to the authorities serially disappointing investors with longer term solutions for the western economies,” said Richard Batty, a global strategist at Standard Life Investments. “Overall, today’s announcements are not a panacea for Europe’s problems.”

Ahead of Wednesday’s concerted intervention by central banks, the composite German one-year bond yield fell as much as 15 basis points to a negative 0.07 per cent, the biggest one-day drop since early August and to the lowest level since at least 1995. By late afternoon, the yield was still a negative 0.02 per cent.

German bond yields also narrowed on speculation that the European Central Bank will also slash its benchmark interest rate - currently at 1.25 per cent – at a monetary policy meeting on December 8.

Shorter-term German treasury bills maturing in less than a year have been negative for some time.

“Investors are retrenching and paying for safety,” said Alberto Gallo, a senior credit strategist at Royal Bank of Scotland. “It’s a function of all the uncertainty, and the big decisions that need to be made in the coming days.”

There are mounting fears that the strains of government indebtedness could rip the eurozone apart. Banks and businesses have started to make contingency plans for such an event, and bankers and analysts have called on the European Central Bank to act as a lender of last resort to forestall a resulting financial cataclysm.

Finance ministers are weighing more radical options to strengthen the European Financial Stability Facility, the eurozone rescue fund.

However, even if the ECB or the IMF do assume a larger role – and Germany has resisted allowing the ECB to support the indebted peripheral countries more strongly – the eurozone economy looks set for a recession next year.

While inflation remains stubbornly high, consumer and business confidence has been hammered by the resurgent sovereign debt crisis, and eurozone unemployment surged to 16.6m in October, a fresh euro-era high.

“The risk is that banks will not extend lending again, even if the ECB steps in more forcefully,” Mr Gallo said. RBS forecasts that the default rate of companies will more than double from 2.6 per cent to 5.6 per cent next year, due to the recessionary risks and tighter lending.