LONDON: Yields on German 10-year Bunds fell below 0.50 percent on Wednesday for the first time since the European Central Bank eased monetary policy last month.
Long-term inflation expectations were a major factor, hitting three-month lows after below-forecast euro zone consumer prices data.
Despite the ECB cutting interest rates deeper into negative territory and extending its bond-buying programme on Dec. 3, the euro five-year, five-year breakeven forward has lost almost 20 basis points since last month's high.
The measure, which now shows where markets expect 2026 inflation forecasts to be in 2021, stands at roughly 1.63 percent, well below the ECB's target of roughly 2 percent. One-year inflation swaps are also at three-month lows of 0.18 percent, having fallen more than 40 basis points since the December highs.
Thirty-year inflation swaps are 1.65 percent, showing the market does not expect the ECB to hit its target in the foreseeable future. Data on Tuesday showed headline euro zone inflation was unchanged at 0.2 percent in December, missing expectations for a rise to 0.3 percent.
The core inflation rate, which strips out energy costs, fell to 0.8 percent from November's 0.9 percent. Concern over an economic slowdown in China and a free fall in oil prices have also taken their toll on inflation expectations in recent months.
This puts downward pressure on euro zone bond yields by encouraging buying.
Benchmark 10-year German Bunds yielded 0.496 percent, down 5.6 basis points on the day and at their lowest levels since Dec. 3.
"European government bond markets are enjoying a (balanced) environment with sliding inflation expectations augmenting the lingering emerging market concerns," Commerzbank rate strategist Michael Leister said. Some analysts also said North Korea announcement that it successfully conducted a test of a nuclear device on Wednesday morning was hurting risk appetite and supporting debt markets.
NO PLAN B Last month, the ECB cut its deposit rate by 10 basis points to -0.30 percent and extended its 60 billion euros a month asset-buying programme by six months until March 2017.
ECB chief economist Peter Praet was quoted as saying in a magazine interview on Wednesday that the ECB's policy was not yet successful but that without those measures the euro zone would have been in deep recession.
The central bank has no Plan B and printing enough money will eventually lead to inflation, he said, adding that the ECB will retain accommodative policies at least until March 2017 and beyond if necessary.
"The ECB will not be pleased to see that inflation breakevens have been on weak footing since the December meeting," Societe Generale strategists said in a note.
"Recent developments will only add pressure on the ECB to ease further -- our economists are looking for another cut in March."
At the first euro zone bond auction of the year, Germany sold 4.04 billion euros of two-year bonds at an average yield of minus 0.38 percent, compared with minus 0.32 percent at a previous sale.
Other euro zone bond yields were also 5-7 basis points lower.
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