LONDON: Two-year German government bond yields dropped to fresh record lows on Friday as banks loaded up on bonds likely to become scarcer after recent tweaks to the European Central Bank's asset purchase programme.
On a day when most high-rated euro zone government bond yields were down 3-5 basis points, the yield on the German two-year government bond, or "Schatz", hit the minus 0.80 percent level for the first time.
Earlier this month, the ECB said it would reconfigure its bond-buying scheme at the start of 2017, introducing changes that suggested it would focus its purchases on short-dated government bonds.
It expanded the eligibility of the scheme to include bonds with maturities of one year and above and bonds yielding less than the deposit rate.
Investors had already faced a shortage of short-dated bonds - which are used as collateral to borrow in money markets - before the changes, but these are expected to intensify.
"The ECB has come up with measures to reduce scarcity, but it's not going to make a sea change," said ING strategist Martin van Vliet, referring to the ECB's move to make a securities lending programme easier to access.
On Thursday, banks rushed to make use of this programme to borrow German government bonds from the Bundesbank, market sources told Reuters.
"The fee is still very punitive for securities lending. Going into next year I would expect the Schatz yield to go up a bit - but it will remain at very low levels," he added.
Mizuho strategists said the struggle to find collateral for repo markets would also narrow the spread between various two-year euro zone government bonds.
"This is most likely to be true for France, as its repo rate is the most likely to hit minus 0.70 percent in the coming months," the strategists said in a note.
French two-year bonds yielded minus 0.66 percent, down 3 bps on the day. The 14 bps spread over German equivalents is narrower than the 10-year spread, which stood at 44 bps.
While high-rated euro zone government bond yields, the bonds of the lower-rated southern European countries were up 1-2 bps on the day.
Greece's 10-year yield fell 5 bps to 7.53 percent, having risen over 60 bps in the two previous sessions.
The sell-off in Greek debt this week came as official creditors suspended a bailout deal after Prime Minister Alexis Tsipras unexpectedly said he would grant low-income pensioners a pre-Christmas payoff.
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