LONDON: Yields on German government bonds of up to five years' maturity traded below the European Central Bank's deposit rate on Monday as money market rates reflected expectations of two further 10 basis point cuts in 2016.
The Bank of Japan's unexpected cut in a benchmark interest rate to below zero on Friday has supported bond markets around the world. The move highlighted the challenges that major central banks face in lifting inflation at a time when China is slowing down and oil prices trade around $35.
German five-year bond yields hit record lows of minus 0.32 percent as markets expected major central banks to be stuck in a race to the bottom on interest rates for the foreseeable future. Two-year yields fell as low as minus 0.486 percent, within a whisker of their record low.
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"Rate cut speculation looks set to continue after the BOJ went negative," said Commerzbank rate strategist Rainer Guntermann.
The rules of the ECB's 1.5 trillion euro stimulus programme stop it from buying bonds whose yields trade below the deposit rate, which is now minus 0.30 percent. The ECB then has to compensate by buying longer-term bonds in larger amounts.
Ten-year Bund yields, the benchmark for euro zone borrowing costs, briefly fell to 0.236 percent. It was their lowest since April 2015 when they were in the middle of a snowballing sell-off that took them from almost zero to above 1 percent in a matter of weeks.
In money markets, the difference between forward overnight rates dated for the March ECB meeting and the average spot Eonia rate in the past month suggested expectations of a 10 basis point cut in the deposit rate. Another such move was fully expected by July or September.
"CYNICAL" MARKETS
While the market expects more monetary policy easing, it does not necessarily think it is going to work.
The five-year, five-year breakeven forward rate , which measures where markets see 2026 inflation forecasts in 2021, was just above 1.50 percent, trading at levels seen before the ECB launched its bond-buying programme.
It has fallen more than 15 bps this year and remains far off the ECB's inflation target of just below 2 percent.
"The market is cynical, it doesn't care whether the ECB gets it right or not," said Gianluca Ziglio, executive director for fixed income at Sunrise Brokers.
"If they don't achieve their target, the market is even more happy because rates can go even lower. It's easy to be long, it's much more difficult to pick the right time to be short."
Other euro zone bond yields crept higher in late trade, while Italy said it has hired banks to sell a new 30-year bonds via a syndicate. The bond is expected to be launched and priced in the near future.
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