(Bloomberg) -- European short-dated bonds rallied as traders added to wagers that the European Central Bank will lower interest rates by half a percentage point in December, in a bid to prop up the bloc’s flagging economy.
The yield on German two-year notes fell as much as eight basis points to 2.10%, erasing its jump since Monday when bond markets suffered a sharp selloff. Swaps imply around a 45% chance of a half-point reduction at the final ECB meeting of the year, in contrast to last week when only a quarter-point move was envisaged.
The moves reflect growing appetite for European bonds, with many investors favoring the region over the US where the economic outlook looks more robust. Traders are pricing 25 basis-point cuts at every ECB gathering through to June, nearly 20 basis points more than what’s seen from the Federal Reserve over that time-frame.
“We believe European fixed income investments continue to look appealing, offering attractive yields today as well as possible price appreciation should conditions weaken,” Pacific Investment Management Co. economists Nicola Mai and Peder Beck-Friis wrote in a note on Wednesday.
The repricing toward more ECB easing picked up after Reuters reported Wednesday that the central bank is starting to debate whether interest rates should be cut below neutral, to a point at which they’re stimulating the economy. Inflation is already below the 2% target and former powerhouse Germany is in recession.
“Ultimately, the data will determine December’s outcome,” said Andrzej Szczepaniak, a senior macroeconomist at Nomura. He expects activity surveys this week including PMIs for October to show continued weakness, which “should provide some support to near-term ECB pricing.”
Longer-dated bonds also edged higher on Wednesday, thought the moves were milder. Germany’s 10-year yield slipped two basis points to 2.30% after touching its highest level since early September on Tuesday.
ECB policymakers, who have already cut interest rates three times this year, have signaled in recent days that they could be open to a faster pace of easing. Mario Centeno said Tuesday that data will decide whether a 25 basis-point or 50 basis-point reduction is appropriate, while Robert Holzmann — widely known as a hawkish official — said more rate cuts will follow.
--With assistance from James Hirai.
(Updates prices, context, adds investor comment in paragraph four.)
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