Euro zone bond yields climb on hopes for Brexit deal

LONDON (Reuters) - Euro zone bond yields rose on Monday as investors sold safer assets on the receding risk of a British no-deal exit from the European Union and in the belief that the UK parliament could soon approve a Brexit agreement.

FILE PHOTO: The logo of the European Central Bank outside its headquarters in Frankfurt, Germany, April 26, 2018. REUTERS/Kai Pfaffenbach/File Photo

Optimism over Brexit negotiations after the EU and Britain agreed a new deal last week has fueled a selloff across euro zone bond markets, as some sort of resolution to Brexit would help tame a key uncertainty facing both the euro zone and British economies.

Analysts said Brexit would remain the dominant driver for euro zone bond markets until economic data released later in the week, including flash purchasing managers’ index surveys.

The deferral of a vote on the withdrawal agreement in the UK parliament on Saturday has reinforced optimism, as lawmakers forced the government to seek a delay to the Oct. 31 deadline for Britain’s leaving the EU.

The British government will now need to push on with legislation needed for ratification of the Brexit deal, after the parliamentary speaker halted the government’s attempt to hold a vote on the deal on Monday.

Natixis rates strategist Cyril Regnat said media reports suggesting Johnson could get his deal passed were encouraging investors to buy riskier assets and hurting euro zone bonds.

However, he said the market should be more nervous, because the threat of a no-deal Brexit remained as long as Brussels did not signal it would delay the Brexit departure date.

“As long as the EU is not ready to send a clear sign of its willingness to extend, I don’t see why we should have optimism around risky assets,” he said.

Benchmark 10-year German government bond yields extended their rise on Monday, gaining as much as 4 basis points to -0.34% DE10YT=RR, close to three-month highs.

(Graphic: German 10-year bond yield, )

Given the scale of the bond market sell-off since the first signs of a Brexit deal emerged - with Germany’s 10-year bond yield rising 21 bps since Oct. 10 - analysts expect any further rise in yields if a Brexit deal is approved to be limited.

Commerzbank rates strategist Rainer Guntermann said he saw yields rising up to 5 bps as an immediate reaction if a deal is approved, as “most of the Brexit excitement is in the price now”.

The outlook was also supported by White House economic adviser Larry Kudlow expressing optimism about ongoing U.S.-China trade talks and saying tariffs scheduled for December could be withdrawn if negotiations continue to go well.

The Brexit optimism and hopes that a downturn in the euro zone economy is bottoming out has also lifted inflation expectations.

A key market gauge of long-term euro zone inflation expectations briefly rose to a one-month high of 1.249% EUIL5YF5Y=R.

“The (economic) data are expected to show very mild improvement, confirming that a bottom-building period is on its way,” UniCredit strategists said.

They added that an improvement in line with expectations was already priced into bond markets.

Italian bonds underperformed on Monday, with the 10-year yield up 6 basis points IT10YT=RR.

The European Commission sent a letter to Italian authorities asking for clarification over its 2020 draft budget and Rome will reply by Wednesday.

Investors are also preparing for European Central Bank President Mario Draghi’s final policy meeting on Thursday, although no significant policy shifts are expected following the announcement of a stimulus package at the last meeting.

Reporting by Tommy Wilkes and Yoruk Bahceli; Editing by Alison Williams and Kirsten Donovan