Europe News

Bund yields hit new lows on weak euro zone outlook


German Bund yields fell to a record low on Wednesday as worries over a deteriorating euro zone economic outlook, fed by another credit rating blow for France, and "free falling" inflation expectations dominated the market.

Yields jumped in Greece, where investors are worrying about the risk of snap elections and Athens' plans to exit its bailout early.

Bear and bull statues are pictured in front of the Frankfurt Stock Exchange in Frankfurt, Germany.
Thomas Lohnes | Getty Images

Data releases continued to undershoot expectations, with the latest being a 0.6 percent fall in Finnish economic output in August that followed a revised decline of 1.2 percent in July.

A key business survey on Tuesday fueled concerns that Germany may face recession.

Read MoreWhere didthe German 'strongman' go?

The weak economic data pushed one of the most closely-watched measures of inflation expectations to new record lows, increasing the pressure on the European Central Bank to ease monetary policy further.

"Investors are looking at the risk of quite depressed economic growth or recession in the euro zone," said Alessandro Giansanti, senior rates strategist at ING.

"Inflation expectations are in free fall so I think there is no other option for the ECB then to rush in and buy government bonds as soon as possible."

There also seems little point in looking elsewhere in the region for a growth kick. Fitch placed France's AA+ rating on negative watch late on Tuesday, citing risks to the economic outlook and deficit-reduction plans.

ECB 'can't do more': Pro

That followed Standard & Poor's revision of France's AA outlook to negative from stable last week.

German 10-year Bund yields, which set the standard for borrowing costs in the euro zone, hit a record low of 0.824 percent, 2 basis points lower on the day.

"Given the already very low yield level, Bunds are likely to find it increasingly difficult to advance further," said Manfred Bucher, senior analyst at Bayerische Landesbank. "However, they remain well supported amid increasing skepticism on the economy and deflation concerns."

Read MoreGerman investor morale tumbles as contraction looms

France's 10-year yields also fell to 1.18 percent, with the ratings move not hurting the appeal of its debt as markets are focused more on the impact a weakening outlook would have on central bank policy.

Free fall

The euro five-year, five-year breakeven forward, which shows where markets expect 2024 inflation forecasts to be in 2019 was around 1.76 percent, a record low. It has fallen 20 bps in the past month.

Annual inflation in the euro zone slowed to just 0.3 percent in September and oil prices around four-year lows are stoking fears the euro zone could fall into deflation, which could cripple economic growth even more.

Read MoreGreek bond yields pass 7% as worries return

"With deflation worries still very much to the fore in the euro area and the pressure on the ECB to take further action in coming months, Bunds will remain underpinned in the near term," said Nick Stamenkovic, bond strategist at RIA Capital Markets.

Greece was the only market in the euro zone which ignored prospects of ECB easing. Ten-year yields rose 55 basis points to 7.60 percent, their highest since March.

Investors fear that an early exit from the bailout program would derail Athens' fragile fiscal progress and that snap elections are inevitable next year when a presidential vote is held. That brings the prospect of a political deadlock or a government led by the radical leftist Syriza party, which has campaigned against austerity.

"Investors are worried that Greece cannot survive alone," ING's Giansanti said.