Borrowing rates for eurozone countries collapsed to new record lows on Friday as investors snapped up government bonds based on the European Central Bank's quantitative easing shopping list. To boost the ailing euro zone economy and prevent deflation from setting in, the ECB said it will buy 60 billion euros of assets a month from March, focusing mainly on sovereign bonds.
The 18-month quantitative easing programme is already surpassing initial expectations for 500-700 billion euros of stimulus and could even be extended. The ECB will also bear 20 percent of the risk of holding the debt, with the rest taken by the national central banks, surprising some investors who did not expect any mutualisation of risk in the euro zone. Bond purchases will cover maturities of up to 30 years - longer than many in the market had expected.
"The new programme is massive, and we are optimistic about its potential impact," said Jon Jonsson, senior portfolio manager in the global fixed income team at Neuberger Berman. Spanish 10-year bond yields fell to new record lows of 1.25 percent, while Italian yields hit 1.41 percent. Both fell more than 10 basis points on the day. German 10-year Bund yields, which set the standard for euro zone borrowing costs, hit new lows as well at 0.305 percent, but the gap between the yields on top-rated debt and lower-rated bonds narrowed sharply to some of the tightest levels since the early years of the currency union.
Even German 30-year yields fell below 1 percent for the first time, while two-year yields traded as low as minus 0.18 percent. Italian and Spanish 30-year yields were 25 bps lower at 2.54 percent and 2.31 percent. "The inclusion of the very long end in the eligibility pool should benefit the periphery in particular over the medium term," said Orlando Green, rate strategist at Credit Agricole.
In a sign of what investors believe the impact of QE will be on the real economy, market-implied inflation expectations rose sharply. But they still suggested price growth would remain below the ECB's target in the coming decade. "The ECB's QE package has met the market's crucial test of 'whatever it takes' but the question that remains now is will it be enough to reflate real economies," said Lena Komileva of G+ Economics.
Greek bonds were swept up in the rally, driving 10-year yields down 34 bps to 8.78 percent as investors heaved a sigh of relief that Greece had not been excluded from the QE scheme, offsetting any caution ahead of snap elections. The ECB's purchases will, however, only include junk-rated bonds if the issuer is in an international financial assistance programme. The Greek vote is likely to be won by the far-left Syriza party, which promised to tear up the bailout programme, end austerity and renegotiate the debt owed to the European Union.
But QE will leave investors scrambling for returns on their money, and if Syriza can reach a compromise with Berlin and Brussels, high-yielding Greek bonds are bound to rally further. "All parties involved are interested in the negotiations being successful," said Christoph Rieger, rate strategist at Commerzbank. "In the end, there will be a third aid package and further debt relief. A Grexit or a second debt restructuring with private creditors remains very unlikely."