40% Of European Government Bonds Sport Negative Yields, And More May Follow

More ECB stimulus could push yields even lower.

Image: Bentley Smith

Growing expectations that the European Central Bank will expand its monetary stimulus at its meeting on Thursday have helped push eurozone government bond prices higher and yields further into ultralow and negative territory.

Around 40% of government bonds in Europe now trade with negative interest rates, which amounts to about €3 trillion ($3.18 trillion), Deutsche Bank analysts noted this week, in a note.

As the chart below shows, the bulk of the negative-yielding government bonds come from eurozone members Germany and Finland, as well as nonmember Switzerland, which has embarked on an aggressive monetary stimulus plan of its own that includes a hefty 0.75% charge on deposits held at the Swiss National Bank.

Image: MarketWatch.com
Image: MarketWatch.com

The ECB earlier this year implemented an aggressive bond-buying program in an effort to boost inflation, which remains stubbornly well below its target of near but just below 2%. In June 2014, the ECB became the first major central bank to cut its deposit rate below zero, meaning banks must pay the central bank to hold their deposits. The deposit rate stands at minus 0.2%.

While analysts largely expect the ECB to make a move on Thursday, they are still debating on which tools the bank will use.

Analysts widely expect the ECB to both increase the dollar amount of bond purchases and extend its bond purchase program beyond September 2016. The ECB is also expected to take the deposit rate even deeper into negative territory. See: This chart shows how European bond markets might react to ECB decision.

Expectations for additional easing have pushed yields down even further in the past couple of weeks, with new countries, such as Italy, entering negative-yield territory. Six-month Italian bills last week saw negative yields for the first time.

Analysts from Danske Bank, Berenberg and RBC Capital Market expect a 20 basis point cut to the deposit rate to negative 0.4% at Thursday’s meeting, with the ECB keeping the door open for further reductions.

All else equal, a cut in the deposit rate would push yields lower, as it would increase the volume of bonds eligible for purchase by the ECB, wrote analysts at Capital Economics in a Wednesday note. The ECB has said it won’t purchase bonds with yields below the deposit rate. Bond yields fall when prices rise and vice versa.

As the following chart shows, if the ECB cuts its deposit rate to minus 0.4%, nearly 100% of core European government bonds with maturities between 2 and 30 years would be eligible for purchase by the central bank.

Image: MarketWatch.com
Image: MarketWatch.com

Source: MarketWatch.com