LONDON: German Bund yields bounced off record lows on Wednesday after euro zone inflation data showed sinking oil prices did not push down the cost of other goods and services, although expectations for more ECB easing remained high.
Euro zone markets at large were dominated by speculation on how the inflation data might affect European Central Bank policy, but Greek 10-year yields rose above 10 percent on resurfacing fears that Athens might leave the currency union.
Euro zone consumer prices, dropped by 0.2 percent in December, which was a sharper fall than expected.
But core inflation, which ECB members have in the past favoured and excludes volatile energy and unprocessed food prices, held steady at 0.7 percent. Inflation excluding tobacco and alcohol inched up to 0.8 percent.
That fuelled some expectations that cheap oil might unlock disposable funds which can be spent on other goods and services, leading to a pickup in headline inflation later on.
"It is crucial to differentiate what kind of deflation is at play," said Samy Chaar, chief economist at Lombard Odier. "The figures ... are skewed because of the low oil price ... Overall, what we have is good disinflation."
German 10-year Bund yields last traded flat at 0.46 percent, coming off a record low of 0.433 percent hit earlier in the day. Dutch, Belgian, Austrian and Finnish bonds yields also bounced off troughs.
Markets still expect the ECB to tackle the risk of a prolonged period of deflation by launching a large-scale government bond purchases programme early in the year to help bring the headline inflation back to the bank's near 2 percent target.
"The emergence of negative inflation does forcefully raise the spectre of a possible prolonged period of deflation," said James Ashley, chief European economist at RBC Capital Markets.
"In other words, for those policymakers who, hitherto, might have been undecided over whether or not to take further action immediately, this may be just the clarion call that was required to appreciate the gravity of the situation."
The ECB would be worried that the euro five-year, five-year breakeven forward, which shows where markets expect inflation forecasts for the beginning of 2025 to be at the start of 2020, traded as low as 1.57 percent.
Illustrating fears that the euro zone might succumb to a prolonged period of growth-crippling deflation, 30-year German yields traded at 1.15 percent, just below equivalent Japanese yields. The last time long-term German yields traded lower than Japanese yields was at the height of the euro zone debt crisis in mid-2012.
Rabobank market economist Emile Cardon said the post-inflation blip in Bund yields is likely to be capped by expectations that the Swiss National Bank will invest the euros it bought to cap the red-hot franc in top-rated bonds.
"I expect the SNB to buy euro-denominated assets to protect the 1.20 level. This is partly why we've seen such falls in Bund yields earlier today and one reason why the upside in Bund yields is limited," he said.
ECB easing expectations shielded peripheral euro zone markets from the selling pressure in Greece.
Spanish and Italian 10-year bond yields were little changed at 1.65 percent and 1.86 percent, respectively. Greek yields, however, rose almost a full point to 10.58 percent.
The worry is that a win for the far-left Syriza party in Greece's election on Jan. 25 may lead to stand-off between Berlin and Athens over the austerity measures agreed as part of bailout deals worth 240 billion euros.
Syriza insists it wants to keep Greece in the euro but has promised to end austerity and renegotiate its debts to the other euro zone members.
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