Investors ran for the safety of top-rated German debt and ditched bonds in riskier southern Europe on Fridayas Britain's vote to leave the European Union gave euro zone markets their biggest shock since their 2012 crisis.
Investors ran for the safety of top-rated German debt and ditched bonds in riskier southern Europe on Fridayas Britain’s vote to leave the European Union gave euro zone markets their biggest shock since their 2012 crisis.
German bond yields an indication of government borrowing costs dropped to record lows while equivalents in the likes of Spain, Italy and Portugal shot to multi-month highs.
The vote forced the resignation of Prime Minister David Cameron, paves the way for another Scottish independence referendum and deals a blow to unity across continental Europe at a time when other breakaway movements are gaining ground.
“Brexit is not just a UK issue. It is an issue for Europe and it is just the start of Europe having to figure out where the future lies,” Mizuho strategist Peter Chatwell said.
German yields across all maturities plumbed record lows, with the 10-year benchmark falling as low as minus 0.17 percent , on track for its biggest drop since the height of the euro zone crisis in August 2012.
The decision to leave by Britain, which accounts for around a sixth of the bloc’s economic output, has emboldened eurosceptics in other member states, with populist leaders in France and the Netherlands demanding their own referendums.
“Prior to the Brexit vote, there were many countries that were not happy with the EU and that would like to see change; if that is exacerbated, then the impact on bond markets could be quite significant,” said David Zahn, head of European fixed income at Franklin Templeton.
But the market fallout was most keenly felt in southern European countries like Spain, which is grappling with a separatist movement in Catalonia and is set to return to the polls this weekend for the second time in six months.
Ten-year yields in Spain rose 15 basis points to 1.62 percent, with the premium it would pay to borrow over benchmark Germany stretching to its widest in more than two years.
The cost of insuring Spanish debt against default as measured by credit default swaps rose to its highest since at least late 2014.
In Portugal and Greece, the two junk-rated borrowers in the euro zone, yields surged 27 bps and 96 bps, respectively, although by midday all peripheral yields were off highs hit earlier with traders saying the European Central Bank’s asset purchases had helped calm markets.
Money market rates implied that the European Central Bank will cut interest rates by September, with around a 60 percent chance seen for a cut at its next meeting in July.
Citi said in a note that, in the coming days and weeks, it also expected the Bank of England and other European central banks to cut rates, and the US Federal Reserve to delay its next hike to December 2016 or beyond.
Any perceived hit to near-zero inflation in the euro zone could certainly tip the ECB towards further easing.
A key measure of the bloc’s long-term inflation expectations, the five-year, five-year forward rate, slumped to a record low of 1.34 percent, moving further away from the ECB’s target of close to 2 percent.
“On the European continent, we have to brace ourselves for serious ripple effects. The Brexit shock, the resulting uncertainty and likely market upheaval will also dampen growth in the euro zone for the remainder of this year,” said
Holger Schmieding, chief economist at Berenberg Bank in London.