UPDATE 1-Italian bond yields spike, euro zone inflation expectations tumble on recession fears

* Italian short-end takes big hit after lockdown in wealthy region

* Safe-haven German bond yields plunge to record lows

* Euro zone inflation expectations fall below 1% (Adds details, context, quotes)

By Yoruk Bahceli and Dhara Ranasinghe

LONDON, March 9 (Reuters) – Italian bond yields soared on Monday while safe-haven German debt yields hit new record lows and euro zone inflation expectations tumbled to unprecedented levels as a crash in oil prices amplified recession fears spurred by coronavirus.

A move by Saudi Arabia to raise crude output pummelled oil prices and heightened fears of a global recession plunged European stocks into a bear market on Monday.

The number of coronavirus cases spiked over the weekend, with both new infections and the death rate showing their largest daily increase in Italy – the current focus of the crisis – since the start of the outbreak.

Yields on Italy’s government bonds shot up after the country ordered a virtual lockdown across much of its wealthy northern region.

Short-end bonds took the biggest hit. The two-year yield jumped as much as 56 basis points to 0.646%, the highest since June 2019. It was last up 22 basis points at 0.28%

Italy’s 10-year yield was last up 18 bps at 1.25%.

That pushed the gap between Italy and euro zone benchmark German 10-year yields – a key measure of risk on the former – above 200 bps for the first time since August 2019 .

Euro zone inflation expectations sank below 1% for the first time ever – far off the ECB’s close to but lower than 2% target.

The 10-year Bund yield – the euro zone’s leading safe asset – fell to a new record low of -0.863%. It was last down 10 bps on the day at -0.83%. The 30-year bond yield – the longest on Germany’s yield curve – also fell to a record low of -0.60%. It was last down 15 bps at -0.46%

“It’s all adding to the pressure on the ECB,” said Commerzbank rates strategist Rainer Guntermann, as the move is likely to have a big downward impact on euro area inflation due later this month.

Money markets are fully pricing in the probability that the ECB will cut interest rates by 10 bps at its meeting on Thursday, but the focus is on whether this will suffice.

“I think a response from the ECB in terms of QE (quantitative easing) is necessary as the monetary transmission is broken,” said Mizuho head of rates strategy Peter Chatwell, referring to the bank’s bond purchases.

“If they do nothing then the yield curve could invert in Germany,” he added, referring to a key gauge that is usually taken as a sign of an upcoming recession.

The gap between two and 10-year Bunds is at its tightest since 2008 .

Pledges by governments to increase spending to tackle the impact of coronavirus failed to soothe markets.

Germany promised aid to companies hit by collapsing demand , while Italy’s government will further increase spending in a “massive shock therapy” to offset the economic impact of the coronavirus outbreak, the prime minister said on Monday.

He added that the government would use the flexibility envisaged by European budget rules “in full”. (Reporting by Yoruk Bahceli and Dhara Ranasinghe; Editing by Emelia Sithole-Matarise)

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