Explainer: German bond yields

What exactly is happening in German bond markets?

A sell-off in Bunds, or 10-year German debt, has accelerated sharply this week. With prices falling, yields - the costs to Berlin of borrowing in markets, which move inversely with prices - have shot up. Just three weeks ago, Bund yields were as low as 0.05 per cent and many market experts expected them to turn negative. By morning trading in London on Thursday, they had risen as high as 0.78 per cent.

Why is the sell-off a big deal?

European government debt markets are usually stable with yields moving only by a few hundredths of a percentage point in a day. The past few weeks have seen Bund market volatility soar and heavy losses inflicted on investors, with the fall in the capital value of their holdings wiping out meagre interest payments. German Bund yields act as benchmarks for European financial markets, so the effects have ricocheted. Germany's Dax share index has dropped 9 per cent from its peak on April 10. Eurozone share prices are down 7 per cent over the same period. Higher yields have also helped push the euro higher against the dollar.

What is the cause?

There has been no obvious single trigger but a lot of attention is focused on the role of European Central Bank "quantitative easing". Heavy Bund purchases by the ECB sent yields lower in the first part of the year. This week's sell off might have been because too many investors believed bond yields would only go down; crowded positioning left the market vulnerable to small shifts in sentiment.

One cause of that shift in sentiment were signs that the eurozone has averted a damaging deflationary slump. Credit and inflation data have pointed to a modest revival in economic activity. Crucially, expectations about future inflation rates priced into markets have picked up - largely because oil prices have also started to rise.

Does this mean QE is working?

Logically, Bund yields would rise if investors expected stronger eurozone growth and higher inflation. But the consensus view in markets is that the latest moves are more about a correction than a fundamental shift in investors' views. The US and Japanese experience shows that choppy conditions in bond markets follow the launch of large-scale asset programmes, muddling the signals bond yields send about the state of the economy. What is more, a stronger euro could hit eurozone exports - so it is too early for Mario Draghi, ECB president, to celebrate. With the ECB continuing to buy €60bn in public and private sector assets each month, bond yields could return to a downward path.

Is Greece to blame?

Possibly. When fears about a eurozone break-up rise, German yields generally fall, as Germany is seen as a safe place for investors to put their money. If markets were less worried about Greece, yields would be higher. But Greece can hardly explain the size of recent moves - especially as worries about the country's ejection from the eurozone remain high.

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