Euro zone bond yields drop as contagion risks still spook markets
By Stefano Rebaudo
March 20 (Reuters) -Euro zone borrowing costs dropped, and yield spreads between core and periphery widened on Monday as risks of a banking crisis continued to spook investors after UBS sealed a deal to buy Credit Suisse and some of the world's largest central banks teamed up to reassure markets.
UBS UBSG.S will pay 3 billion Swiss francs ($3.2 billion)for Credit Suisse, and the Swiss central bank (SNB) said it would supply substantial liquidity to the merged bank.
The Federal Reserve joined forces with the Bank of Canada, Bank of England, Bank of Japan, European Central Bank and SNB in a coordinated action to enhance the provision of liquidity through their standing U.S. dollar swap line arrangements.
German government bond yields hit their lowest since mid-December, with the 10-year yield DE10YT=RR, the bloc's benchmark, down 15 basis points to 1.97% after reaching 1.951%.
"It’s very difficult to have a clear view of what’s happening in the banking sector" said Joost van Leenders, senior investment strategist at Van Lanschot Kempen.
"We saw measures by central banks; it was a bit of a shock for financial markets, which worry that something broader is going on," he added.
Italian government bonds underperformed their German peers as appetite for risky assets dropped dramatically.
The spread between Italian and German 10-year yields DE10IT10=RR was last at 201 bps after hitting its widest level since early January at 205.6 bps.
Italy's 10-year yield IT10YT=RR dropped 7 bps to 3.98%. Bond yields move inversely with prices.
"Market perception depends on sentiment as much as on facts, being driven by balance sheet exposures, hedge coverage, and real-time deposit (out)flows - which are by and large private information," said Michael Leister, head of interest rates strategy at Commerzbank.
DOWNGRADING EXPECTATIONS
Markets kept downgrading their expectations for the next ECB moves, showing they were cautious about recent ECB statements.
President Christine Lagarde underlined last Thursday a clear separation of the monetary policy path and the financial stability objective, adding that the ECB policy tool kit is fully equipped to provide liquidity support and to preserve the smooth transmission of monetary policy.
The August 2023 ECB euro short-term rate forward dropped as low as 3.0%, implying expectations for a depo rate peak at 3.1% by summer from above 4% before fears of a banking crisis started hitting markets on March 10.
The ECB deposit rate is currently at 2.5%.
Meanwhile, ECB hawks kept pressing the case for more rate hikes, even above 4%.
Inflation in the euro zone is proving tougher to crack than expected, and the ECB will likely need to raise interest rates further, possibly above 4%, Austrian central bank chief Robert Holzmann said on Saturday.
The ECB is likely to keep raising interest rates as a repeat of the 2008 financial crisis is unlikely, with European banks subject to tougher rules than regional U.S. banks, Belgian central bank chief Pierre Wunsch said.
Markets' focus will shift to the Federal Reserve policy meeting, which ends on Wednesday.
Most analysts expect a 25 bps hike, but they reckon much will depend on whether a modicum of stability returns to financial markets, especially for regional banks.
Reporting by Stefano Rebaudo, editing by Ed Osmond
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