Investors flee stricken region as German bonds dive

Investors fled the eurozone last week after German government bonds, its last haven, fell on fears Germany would have to pay for the bloc’s financial crisis.

Bund yields rose 10%, from 1.9% to 2.1%, in a single day after the German government sold investors just two thirds of the bonds it intended to at auction.

At a meeting after the auction, France, Germany and Italy, the three largest eurozone economies, agreed to move towards a fiscal union, or pooling their revenues in an attempt to strengthen their finances. (article continues below)

However, they made no plans to pool eurozone borrowing in a so-called eurobond scheme, which could smooth eurozone members’ chaotic attempts to tap the capital markets.

Since the summer, the European Central Bank (ECB) has bought eurozone government bonds through its Securities and Markets Programme. However, this has failed to support their plummeting value.

Despite this, the three countries said they would put no additional pressure on the bank to create money to buy government bonds, in a quantitative easing of monetary policy (QE). Although it recently lowered rates by a quarter of a percentage point, the ECB is especially hawkish on inflation in the bloc following Germany’s hyperinflation in the 1920s.

However, economists increasingly argue deflation is the main enemy following recent austerity in the eurozone.

Simon Ward, the chief economist at Henderson Global Investors, says in a note that “a country-neutral QE operation – with purchases spread across national markets in proportion to GDP or population – would emphasise the monetary motivation and counter criticism of a backdoor fiscal bailout.”

“Money printing is necessary to head off deflation if the banking system is destroying deposits by accelerating deleveraging in response to sovereign bond losses and misguided regulatory pressure,” he says.

Investors are increasingly convinced Germany and the ECB will have to borrow more to foot the bill for struggling members. However, concerns about the latter’s financial position did not abate in anticipation of help from core institutions.

Last week Fitch downgraded Portugal to junk status with a negative outlook, although the ailing country recently met the criteria for a new tranche of funds from the international community.