Brexit turmoil boosts demand for safe-haven German bonds

LONDON: Top-rated German government bond yields tumbled to over two-week lows on Thursday after British Brexit Secretary Dominic Raab resigned, thrusting Prime Minister Theresa May's government into turmoil after she clinched a Brexit deal.

Sterling fell 1.5 percent against the dollar  and 10-year British gilt yields dropped over 13 basis points in their biggest one-day fall since August 2016, sending aftershocks across European markets.

Yields on higher-rated bonds in the euro area were down 4 to 5 basis points, led by euro zone benchmark bond issuer Germany.

The 10-year yield on German bonds, regarded as some of the safest assets in the world, was down 4.5 basis points at 0.36 percent -- its lowest in over two weeks.

"The reason we have a risk-off mood in the euro zone is driven by the UK," said Rabobank rates strategist Lyn Graham-Taylor. "We've also seen wider bond spreads in the periphery, so this is clearly a spillover from Brexit."

Borrowing costs in Spain, Italy and Portugal all faced upward pressure as investors stayed away from riskier assets after the developments in Britain injected fresh uncertainty into world markets.

European Union leaders will meet on Nov. 25 to endorse the divorce deal. May now faces the much more perilous struggle of getting parliament to approve the agreement.

"The Brexit deal is dead in the water with the resignation of Brexit minister Dominic Raab, and this could be the end of the road for May," said Naeem Aslam, chief market analyst at Think Markets UK.

In Italy, positive developments held shield Italian bonds from the risk-off sentiment sweeping markets.

Italian bond yields had opened lower after local reports said that Prime Minister Giuseppe Conte is seeking to work with the European Union on a budget impasse to avoid massive fines.

Analysts said that was a sign the head of Italy's anti-establishment coalition government was looking for constructive dialogue with the EU after re-submitting a draft budget at Brussels' request earlier this week with only minor tweaks.

"I think Conte is playing the good cop here, as he should, and that is feeding through into BTPs at the moment," said ING strategist Martin Van Vliet.

"Any wider trigger for BTP spreads to widen are not really there. The pathway to eventual sanctions is very long and the chances are low that it will come to that," he said.

Italy's two-year bond yield was marginally lower at 1.33 percent, while five-year yields were a touch higher at 2.76 percent.