LONDON: German 10-year government bond yields could fall close to minus 0.5 percent in the wake of last week's Brexit vote, pressuring the ECB to cut its deposit rate to ensure it can complete its 1.7 trillion euro stimulus scheme.
Several big banks have lowered their forecasts for the German 10-year yield, the euro zone's most important market interest rate, since Britain's shock vote drove it to a record low of minus 0.17 percent as investors piled into an asset viewed as one of the safest in the world.
A further slide in yields would make the already acute scarcity of eligible bonds for the European Central Bank's asset purchase programme even more pressing in Germany, the biggest economy in the euro zone and where most purchases are made.
More than half the German government bonds that might have been eligible for the ECB to buy are out of range because they yield less than the central bank's deposit rate, Swiss wealth manager Pictet calculates.
The ECB, which also buys corporate and other bonds, has set itself limits on what it can buy, including the yield floor.
JPMorgan expects German 10-year yields to fall to minus 0.15 percent by the end of the third quarter from a previous forecast of a positive 0.15 percent. Bunds yielded minus 0.12 percent on Wednesday.
Bank of America Merrill Lynch and DZ Bank see 10-year yields falling to minus 0.25 percent in the coming months, while Rabobank expects them to fall to minus 0.3 percent from a previous forecast of minus 0.1 percent this year.
In a note released after the June 23 Brexit referendum, Societe Generale put the range for German Bund yields at minus 0.25 percent to minus 0.45 percent.
Good news for the sovereigns whose funding costs are priced relative to the Bund yield but a massive headache for the ECB which is scrabbling to find sufficient eligible bonds to buy not only in Germany but smaller euro zone countries too.
The ECB cut its deposit rate to minus 0.4 percent in March and some analysts say a further reduction as well as an expansion of the quantitative easing (QE) programme are likely in coming months.
A Reuters poll showed eight of 19 money market traders polled on Monday saw a 10 basis point cut in the deposit rate within six months. The other 11 saw no change.
"We were anticipating another rate cut and an extension and expansion of QE before Brexit, but the risk is that now comes sooner," said Nordea's chief fixed income analyst Jan von Gerich.
He expected German yields to remain negative for longer than earlier anticipated given the uncertainty unleashed by Brexit.
The idea of investors paying governments to hold their debt - unthinkable a few years ago - has become commonplace in developed country bond markets.
Japanese and Swiss bond yields out to 15 and 30 years, respectively, have negative yields. The aggregate yield in Citi's World Global Bond Index comprising 23 countries is at an all time low of around 0.58 percent.
Peter Chatwell, head of euro rates strategy at Mizuho, said there was a very clear linkage in the downside risks of Brexit and the euro zone economy.
Mizuho forecasts German Bund yields will fall to minus 0.20 percent this year from a previous forecast of zero percent.
"We now have increased tail risks and lower growth expectations," Chatwell said.
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