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EURO GOVT-Bonds slump as central banks stir appetite for risk

Thu, Oct 9 2008, 08:52 GMT
http://www.afxnews.com

LONDON, Oct 9 (Reuters) - Euro zone government bonds fell on Thursday as some appetite for risk emerged after major central banks joined forces to cut interest rate cuts a day earlier and the European Central Bank took fresh steps to boost liquidity.

The two-year swap spread fell to 111 basis points from Wednesday's peak near 117 basis points and other euro zone sovereigns slightly outperformed Bunds, which are seen as the safest and most liquid in the region.

Shorter-dated government debt continued to fare better than their longer-dated counterparts, underpinned by expectations for more monetary policy easing, driving the 2/10-year yield curve to its steepest since February.

As part of that monetary push to help soothe markets battling the worst financial crisis in nearly 80 years, the European Central Bank on Wednesday lowered rates by 50 basis points to 3.75 percent.

The ECB also said it would offer unlimited liquidity in its regularly weekly funding operations at a flat rate of 3.75 percent from next week, to help thaw frozen money markets. See

"They're opening the floodgates for liquidity," said David Schnautz, interest rate strategist at Commerzbank in Frankfurt.

"The bold coordinated moves by central banks have taken the bond market off the boil. We're seeing a bit of relief trading right now."

Interbank rates for borrowing overnight euro and sterling eased, although three-month borrowing remained expensive.

At 0800, December Bund futures were down more than 100 ticks at 115.61 compared with Wednesday's settlement close, having hit a near one-week low of 115.46.

The two-year Schatz yield jumped 10.2 basis points to 3.169 percent, while 10-year Bunds yielded 3.931 percent, up 13 basis points.

These moves saw the 2/10-year yield gap hold around 76 basis points, the steepest level for the curve since late February.

Further weighing on the market was weakness in U.S. Treasuries, which fell on expectations of a tide of new debt supply after the Treasury Department said it would reopen scarce debt issues to boost market liquidity.

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Despite the central bank moves, worries about the health of the global economy persisted. The International Monetary Fund, in its bleakest forecast in years, said the world economy was set for a major downturn with the United States and Europe either in or on the brink of recession.

ECB Board member Lorenzo Bini Smaghi said the ECB will cut its outlook for 2009 economic growth and inflation could head more quickly to the central bank's target of around 2.0 percent by end-2009.

Breakeven inflation rates, a gauge of market inflation expectations, have fallen to multi-year lows in recent weeks as inflation worries gave way to fear of recession.

The 10-year rate based on the 2020 French inflation-linked bonds was at 173 basis points, just off the multi-year low of 171 basis points plumbed on Wednesday and well off highs of above 250 basis points set in July.

Figures derived from rate sensitive EONIA, a weighted average of overnight unsecured lending rates between banks, show that markets have fully priced in the chance of a 25 basis point rate cut by year-end.

"Having embarked on this easing cycle, all of the central banks will find it difficult to pull back now," said Stuart Bennett, senior FX strategist at Calyon.

"We believe that given current economic expectations a 3-percent goal for the refi rate would be reasonable."

In the equity market, the FTSEurofirst 300 index of top European shares gained more than 2.5 percent.

(Reporting by Ian Chua; editing by Patrick Graham) Keywords: MARKETS BONDS EURO

tf.TFN-Europe_newsdesk@thomson.com

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