German real yields fall to new record low on stagflation fears

Euro zone inflation-linked government bond yields fell sharply on Monday as analysts increasingly feared a stagflationary shock that might lead the European Central Bank to keep an easing monetary policy even with inflation steadily above expectations.

Brent crude soared to near $130 a barrel, its highest since 2008 as the United States and European allies explore banning imports of Russian oil.

“Near-term, the eurozone will likely remain in the near-stagflation into which it had fallen with the Delta wave of COVID-19 infections in November 2021,” Holger Schmieding, chief economist at Berenberg, said.

“A recession looks unlikely,” he added. “As we do not know the extent of the surge in prices and the reaction of consumers to it, we cannot rule out a temporary decline in real GDP for two quarters in a row.”

Germany’s 10-year inflation-linked government bond yield fell 10 basis points (bps) to a record low of -2.453%, while inflation expectations surged.

A key market gauge of long-term euro zone inflation expectations rose to its highest level since January 2014 at 2.2316%.

Meanwhile, the German 10-year nominal yield staged a rebound after falling sharply last week, when it recorded its biggest fall since November 2011 as markets scaled back expectations about monetary tightening on concerns about the war in Ukraine.

It was up 3.5 bps at -0.062% by 1001 GMT.

Analysts still have mixed views about how the central bank will respond to the likely economic impact of the conflict.

“The 10 March ECB meeting likely reads hawkish, especially on (the) Asset Purchase Programme (APP), for a market that has been pushing back against normalization,” Citi analysts said in a research note.

“However, explicit delays or new easing seem unlikely amid further inflation surprises,” they added.

Money markets are currently pricing less than 25 bps of rate hikes by year-end, roughly in line with their bets late on Friday. [IRPR]

Deutsche Bank (DE:DBKGn) economists “expect the Ukraine crisis to prevent the (European) central bank from announcing Asset Purchase Programme (APP) tapering at this point”.

“The ECB’s message will reinforce its commitment to price stability and addressing fragmentation,” the German bank said in a research note.

Italy’s 10-year government bond yield rose 6.5 bps to 1.59%, with the Italian German yield spread widening to 164 bps.

This week’s ECB meeting “presents bearish euro duration risk near-term, with the periphery the most vulnerable. Indeed, BTPs look around 8-20 bps rich versus other risk assets”, Citi analysts said. Duration measures the sensitivity of the price of a bond or other debt instrument to a change in interest rates.