Euro zone bond yields fall as German coalition in crisis

LONDON: Germany's government bond yields fell towards recent one-month lows on Wednesday as a row over migration policy in Germany's coalition government rumbled on, raising concerns that the euro zone's biggest economy could be headed for snap elections.

Four hours of talks late on Tuesday between Chancellor Angela Merkel and her conservative Bavarian allies failed to resolve the row, just ahead of a summit of EU leaders who are also divided on the issue.

"The market is quite focused on these political issues ahead of the EU summit, and headlines about the coalition breakdown do tend to move bonds and spreads," said Christoph Rieger, a rates strategist at Commerzbank.

"People had thought no matter what the two parties would stick together, but there was no news this morning to suggest that."

Germany's benchmark 10-year Bund yield briefly dipped 2.5 basis points to 0.305 percent, within striking distance of one-month lows hit this week.

U.S. Treasury and British gilt yields meanwhile hit one-month lows as stock markets came under renewed selling pressure from trade war concerns.

Worries about a global trade war and clear signals from the European Central Bank that a rise in interest rates is some way off have pushed down euro zone bond yields in recent weeks.

Developments in Germany add another dimension to the fall in borrowing costs there.

First, a potential collapse in the coalition raises question marks over the direction of fiscal policy, which investors have expected to be more expansionary given that the pro-spending Social Democratic party controls the finance ministry.

Second, political uncertainty in general tends to benefit German bonds - viewed as one of the safest assets in the world. Analysts said demand for German debt could also be viewed in the context that a coalition collapse would likely hamper Franco-German efforts for closer euro zone integration and would be negative for peripheral bonds.

The Italian/German 10-year bond yield gap was at 253 basis points and close to its widest in almost three weeks.

"The market is focused on the increased tail risk for the euro area that a collapse of the German coalition would lead to and the difficulties in forming another market friendly government," said Peter Chatwell, head of rates strategy at Mizuho.

Bond yields across the currency bloc were 1-4 basis points lower, with analysts noting a recovery in prices a day after investors digested bond supply from France and Spain. A bond's yield and price move in opposite directions.

Spain on Tuesday launched a 10-year bond, sold via a syndicate of banks. While there was strong demand for the new seven billion euro bond, Mizuho noted that the deal was the smallest 10-year launch in two years.