Recovery hopes drive Europe bond sell-off

A sell-off in European government bonds drove borrowing costs sharply higher on Wednesday, raising fears that the impact that eurozone quantitative easing has had in driving down yields could soon be thrown into reverse.

German 10-year bond yields were on track for their biggest weekly jump of 2015 after leaping eight basis points to 0.25 per cent in morning trading in London - a level not seen since mid-March.

"It's a pretty chunky move for the first three hours of the day," said Nishay Patel, strategist at UBS.

France saw similar size moves - as did 10-year UK gilts, although the UK is not part of the eurozone.

Since the European Central Bank announced its landmark quantitative easing programme in January, yields on eurozone government bonds have tumbled relentlessly, with a growing pool of sovereign debt falling into negative territory.

The latest sharp upwards move in yields and volatile trading conditions over the past week, however, could heighten concerns that the bull run in government bonds is drawing to a close as inflation and growth expectations begin to rise.

Economic data on Wednesday added to evidence that continental Europe has avoided a deflationary slump, showing credit conditions improving and consumer expectations about inflation rates also rising. Typically, government bond yields rise when inflation and growth expectations pick up.

Some analysts believe, however, that the large-scale buying under the ECB's asset purchase programme and any resulting shortage of eligible bonds for it to buy - especially of German Bunds - could continue to drive yields lower.

"There is still potential for Bund yields to set a new low over the next month," said Steven Major, head of fixed income research at HSBC. "This said, there is no fundamental value with real yields where they are. It is all technical, buyers are treating Bunds like a commodity."

Yields rose across eurozone bond markets - suggesting common factors behind the moves. Yields on Italian, Spanish and Portuguese government bonds had not fallen as much as Bund yields - largely because of fears about fallout from the Greece crisis - but also rose on Wednesday.

"Holistically a lot of market participants are very keen to enter steepening positions on the back of a pick-up in inflation driven by ECB QE," said Lyn Graham-Taylor, fixed-income strategist at Rabobank.

The sell-off may have also reflected other factors. Early in the morning a particularly weak German five-year bond auction saw the eurozone's largest economy unable to sell the full €4bn on offer, with investors taking just €3.27bn.

Analysts also believed that trades which assumed further falls in yields had become overcrowded, and that a correction was inevitable. Last week, Bill Gross, the veteran bond manager at Janus, said the 10-year German Bund was offering an opportunity for "the short of a lifetime".

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