LONDON: Yields on German 10-year Bunds fell on Wednesday to their lowest levels since the European Central Bank (ECB) eased monetary policy in December.
Long-term inflation expectations, which hit three-month lows following Tuesday's below-forecast euro zone consumer prices data, were a major factor behind the move.
The euro five-year, five-year breakeven forward, which shows where markets expect 2026 inflation forecasts to be in 2021, has lost almost 20 basis points since hitting a high last month.
This is despite the ECB cutting interest rates deeper into negative territory and extending its bond-buying programme on Dec. 3 in an effort to boost inflation in the euro area.
The measure stands at roughly 1.63 percent, well below the ECB's target of roughly 2 percent.
One-year inflation swaps are also at three-month lows of 0.15 percent, having fallen more than 40 basis points since the December highs. Thirty-year inflation swaps are 1.65 percent, showing the market does not expect the ECB to hit its target in the foreseeable future.
Data on Tuesday showed headline euro zone inflation was unchanged at 0.2 percent in December, missing expectations for a rise to 0.3 percent. The core inflation rate, which strips out energy costs, fell to 0.8 percent from November's 0.9 percent.
Concern over an economic slowdown in China and a free fall in oil prices have also taken their toll on inflation expectations in recent months.
This puts downward pressure on euro zone bond yields by encouraging buying. Benchmark 10-year German Bunds fell as low as 0.49 percent, their lowest levels since Dec. 3, before pulling back slightly in late trade to stand 4 basis points lower on the day at 0.51 percent.
"European government bond markets are enjoying a (balanced) environment with sliding inflation expectations augmenting the lingering emerging market concerns," Commerzbank rate strategist Michael Leister said.
Some analysts also said North Korea's announcement on Wednesday that it successfully conducted a test of a nuclear device was hurting risk appetite and supporting debt markets.
NO PLAN B
Last month, the ECB cut its deposit rate by 10 basis points to -0.30 percent and extended its 60 billion euros a month asset-buying programme by six months until March 2017.
ECB chief economist Peter Praet was quoted as saying in a magazine interview on Wednesday that the ECB's policy was not yet successful but that without those measures the euro zone would have been in deep recession.
The central bank has no Plan B and printing enough money will eventually lead to inflation, he said, adding that it will retain accommodative policies at least until March 2017 and beyond if necessary.
"The inflation data yesterday was definitely disappointing and will disappoint the ECB," said Nick Stamenkovic, a bond strategist at RIA Capital Markets. "But risk aversion is also driving bond yields lower."
At the first euro zone bond auction of the year, Germany sold 4.04 billion euros of two-year bonds at an average yield of minus 0.38 percent, compared with minus 0.32 percent at a previous sale.
Other euro zone bond yields were 3-6 basis points lower.
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