ECB Cuts Key Interest Rates

European bonds surge after unexpected rate cut by the European Central Bank.

Euro-area government bonds surged, led by Italian and Spanish securities, after the European Central Bank (ECB) unexpectedly cut its benchmark interest rate to a record low, boosting demand for fixed-income assets.

Italy’s two-year yield fell to the lowest level in more than five months, while the rate on Germany’s two-year notes dropped to the least since May. The ECB reduced the main refinancing rate by 25 basis points to 0.25 percent. The decision was forecast by three out of 70 economists in Bloomberg News survey, with the remainder predicting no change. ECB President Mario Draghi, speaking to reporters in Frankfurt, said weaker growth is a downside risk to inflation.

The additional yield, or spread, investors demand for holding Italian 10-year bonds vs. their German equivalents narrowed four basis points to 242 basis points after dropping to 236 basis points, the least since Oct. 24. Spain’s 10-year yield spread over Germany tightened three basis points to 238 basis points.

“The strong gain in peripheral bonds today reflects a market theme that looser policy and more liquidity will benefit countries like Italy and Spain more than core countries like Germany,” said Lyn Graham-Taylor, a fixed-income strategist at Rabobank International in London. “We expect the yield spread tightening trend to continue.”

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