Article Highlights

  • Inflation gauge nears 1.50 pct for first time this year
  • Investors worry ECB will struggle to meet inflation target
  • Italian yields hit fresh lows as political concerns ease
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Many eurozone government bond yields were close to multi-month lows on Thursday as falling oil prices added to concerns about inflation and whether the European Central Bank would be able to tighten policy anytime soon.

Triggered by Wednesday’s sharp fall in oil prices, a key gauge of long-term euro zone inflation expectations closed in on 1.50 percent for the first time this year, well off its February peak of 1.80 percent.

This raises further doubts about the ECB’s ability to meet its inflation target of just below 2 percent, analysts said.

“It’s not good news for the ECB and it maybe reinforces expectations that (ECB President Mario) Draghi can’t get inflation back on target, a problem in the U.S. as well at the moment,” said ING strategist Martin van Vliet.

“If inflation is not reviving, the ECB needs to keep a loose policy stance, which helps the periphery in particular.”

Lower-rated southern European government bonds are seen as the biggest beneficiaries of the ECB’s bond-buying scheme.

Italian debt outperformed the rest of the market, its 10-year debt dropping 5 basis points to a fresh five-month low of 1.86 percent. Also, the country’s 30-year borrowing costs dropped below 3 percent for the first time since early January.

The yield on Spain’s 10-year government bonds also hit a five-month low at 1.33 percent, down around 4 bps on the day.

Italian government bonds have benefited from a reduction of political risk, after the possibility of a snap election faded and anti-establishment party 5-Star Movement, while riding high in national opinion polls, suffered a beating in local votes.

In addition, 5-Star Movement has also relegated its pledge to hold a referendum on the euro — a key concern for the market — to “plan B.”

But many higher-rated euro zone government bond yields are not far off recent lows either. Germany’s 10-year yield, the benchmark for the region, shed a basis point on Thursday to trade at 0.25 percent, not far from a one-month low of 0.225 percent hit last week.

French and Belgian 10-year borrowing costs are also close to their lowest levels of 2017.

From Chris Scicluna, head of economic research at Daiwa Capital Markets.:

“Central bankers would have thought that after a year, weakness in oil would have been washed away but you can see in the market that market-based inflation expectations move closely with oil prices, for instance, the five-year, five-year forward in Europe.”

Oil turned lower on Thursday after posting gains earlier in the session as traders looked ready to test new lows for crude prices with worries persisting over a global glut. (Additional reporting by Dhara Ranasinghe; Editing by Alison Williams and Pritha Sarkar)