LONDON: Southern European bond yields pulled back from multi-month highs on Tuesday as market expectations of euro zone inflation hit a record low, putting the onus back on the need for further European Central easing.
The five-year, five-year breakeven forward, cited by the ECB as one of its favoured gauges of inflation expectations, fell as low as 1.4740 percent. The measure which shows where markets see 2026 inflation forecasts in 2021, is far below the ECB's inflation target of near 2 percent and has cemented bets that the central bank will inject more stimulus into the economy at its meeting next month.
In addition to battling low inflation, the ECB is trying to weather the impact of a global growth slowdown and turbulence in markets that have this week centred on Europe's financial sector.
Sentiment around banks remains fragile, with the European banking index, which had slumped 5.6 percent on Monday, falling back by another 1.1 percent.
"Market stresses are further dampening hopes of economic recovery and this is feeding into lower inflation expectations and a feeling that central banks need to do more," said Richard McGuire, head of rates strategy at Rabobank. Italian 10-year bond yields fell 5 basis points to 1.66 percent, below a four-month high at about 1.77 percent hit in early trade.
Portugal's 10-year bond yield was flat at 3.22 percent.
In early trade, it hit its highest level in almost nine months at 3.31 percent, with the spread over its German equivalent at its widest level in almost two years.
Yields on safe haven German 10-year bonds briefly fell to a 9-1/2 month low at 0.19 percent before pulling back to 0.22 percent, while two-year bond yields moved off a new record low at minus 0.536 percent.
European banks led a global selloff in financial stocks on Monday as signs of stress in the sector mounted.
That rippled across the globe as US and Asian stock markets fell sharply and with investors piling into safe-haven assets such as Japanese government bonds, 10-year JGB yields turned negative for the first time. US 10-year Treasury yields meanwhile fell to a one-year low at around 1.68 percent, but as pressure released on Tuesday they edged up to 1.75 percent.
Goldman Sachs analysts wrote that while there were no signs of any strain in terms of euro or US dollar funding in money markets for European banks, market liquidity had nevertheless reduced.
Analysts said negative interest rates in Europe were also hurting banks' profitability.
"Rates in Europe are in negative territory and that is also putting pressure on banks," KBC strategist Piet Lammens said.
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