Bunds rally on lack of action from summit

LONDON: German government bonds rallied on Wednesday and were likely to remain supported as French and German plans for closer fiscal integration in the euro zone did little to soothe concerns that the regional debt crisis could still spread.

French President Nicolas Sarkozy and German Chancellor Angela Merkel unveiled plans for economic governance, seen as essential first steps to the eventual fiscal integration within the single currency area many in markets say is needed.

But the meeting revealed no concrete measures to tackle the region's immediate concern: funding for weaker euro zone states.

"Investors are a bit disappointed because the statements were not...as most market participants were expecting: that either the (common) euro bond idea would be filled with some meat on the bone or the EFSF (euro zone rescue fund) would be increased in terms of funding volumes," Kornelius Purps, fixed income strategist at UniCredit, said.

"They tried to find approaches to heal the debt crisis without putting more money on the table but rather by trying to find structural approaches."

Pessimism over the French/German plan increased appetite for safe-haven assets, pushing the German Bund future 48 ticks higher to 133.58.

The 10-year German government bond yield fell 5.3 basis points to 2.27 percent and the two-year yield was down 4.8 basis points at 0.70 percent.

Germany sold 5.6 billion euros of two-year notes at an average yield of 0.73 percent, less than half the yield at the last comparable auction in early July.

FUNDING WORRIES

The French and German leaders vowed to stand side by side in defending the euro and laid the groundwork for future fiscal union.

They called for a president to be elected to represent the euro zone, asked their finance ministers to prepare proposals for a common corporate tax base and tax rate in France and Germany from 2013, and proposed to tax financial transactions.

But markets had hoped for either a boost to the EFSF rescue fund or for a reference to plans for common euro zone bond issuance.

Support for a common bond has grown as it is increasingly seen as a way to allow highly indebted euro zone countries to regain access to commercial markets while providing investors a safeguard through joint liability.

At the very least, analysts had hoped for a boost to the 440-billion-euro rescue fund which is currently not deemed big enough to carry out its increased mandate once national parliaments approve an agreement made in July.

"The current size of the EFSF is not big enough if there is further pressure on Spain and Italy and I think, it's a fairly safe guess, that there will be further pressure," Elisabeth Afseth, fixed-income analyst at Evolution Securities, said.

She said the current size would also limit its ability to buy bonds in the secondary market once it takes over that role from the ECB.

Yields on Spanish and Italian bonds hovered just below 5 percent, pulled down by regular ECB buying of those bonds over the last week, although traders said they were not seeing such purchases on Wednesday.

Analysts have said the ECB needs to maintain consistent and steady purchases of those bonds to keep Spanish and Italian funding costs at affordable levels.

Italian government bond yields were down 2.5 basis points at 4.998 percent and Spanish yields were little changed at 4.991 percent.

Copyright Reuters, 2011