Euro Tests Three-Year High as End-of-Stimulus Fear Batters Bonds

(Bloomberg) -- The euro headed for its strongest level in three years as the region’s buoyant economy was seen increasing the chances of an end to central bank stimulus this year.

The currency jumped, sapping stocks, and bonds slid as a slew of data signaled a potential uptick in inflation in the euro area, after manufacturing growth accelerated to a record in December. The numbers followed comments at the weekend from European Central Bank policy maker Benoit Coeure, who said that unless inflation disappointed there’s a “reasonable chance” the central bank’s extension of QE in October could be the final one.

While Coeure didn’t mention the exchange rate, his comments were a boon for euro bulls and coincided with a period of ongoing dollar weakness. The common currency’s strength is translating into a painful start to the year for Europe’s export-heavy stock markets, while bonds have picked up where 2017 left off, with benchmark German bund yields rising to the highest since October.

“The ECB suggestion that bond buying will not be extended is likely behind the recent push higher in the euro,” said Neil Jones, head of currency sales at Mizuho Bank Ltd. in London. “My sense is the euro will extend beyond its three-year high in the next two weeks.”

The euro strengthened 0.4 percent in a fifth day of gains to $1.206 as of 1:24 p.m. London time. German 10-year yields traded two basis points higher at 0.45 percent. French 10-year yields added two basis points to 0.81 percent, while U.K. 10-year gilt yields climbed six basis points to 1.25 percent. The Stoxx Europe 600 Index dropped 0.4 percent, even after strong gains in Asian equities earlier.

For European equities, the $1.20 level has become an approximate pain threshold. Germany’s DAX Index was among the hardest hit, falling 0.7 percent as exporters including Volkswagen AG and Siemens AG retreated.

Rate Hike Odds

Money markets are now pricing the ECB’s first interest-rate hike since 2011 early next year, with focus in the coming months on whether the central bank changes its forward guidance on any increase to borrowing costs.

In an effort to wean the region off support gradually, policy makers last year decided to halve bond-buying through September, leaving an open question about whether they would carry on after that. ECB bond purchases resumed Tuesday at the slower pace of 30 billion euros ($36 billion) per month, compared to 60 billion euros per month previously.

“The bearish price action in bunds is down to the combination of German inflation and Coeure, giving rise to a re-pricing of QE and rate expectations,” said Commerzbank AG strategist Christoph Rieger. The bank suggests shorting German 10-year bonds in anticipation yields will reach 0.5 percent.

--With assistance from Charlotte Ryan

To contact the reporters on this story: John Ainger in London at jainger@bloomberg.net, Samuel Potter in London at spotter33@bloomberg.net.

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Cecile Gutscher, Sid Verma

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