European bond yields continued to climb on Thursday as traders weighed expectations of higher borrowing from major European economies, which is expected to boost defence spending.
German bonds suffered their worst day since the immediate aftermath of the fall of the Berlin Wall on Wednesday, after soon-to-be Chancellor Friedrich Merz laid out a bumper package of defence and infrastructure spending.
The yield on 10-year bunds—the country’s equivalent of gilts—jumped 30 basis points to 2.93 per cent—the highest since October 2023—in response to the rapid jump in borrowing the plans would entail.
But the value of German bonds – which move inversely to their yields – fell even lower on Thursday morning.
The yield jumped a further 14 basis points when markets opened on what promises to be a pivotal day for the European economy.
European leaders are gathering in Brussels for a set of emergency talks on Ukraine and the continent’s defence spending plans, which could unlock €800bn (£670bn) of funds to go on arms.
And later, the European Central Bank (ECB) will meet to announce its next interest rate decision.
The market is expecting a 25 basis point rate cut. But with European leaders set to loosen fiscal policy to their defence spending, any hawkish comments on the pace of further reductions could deepen the sell-off afflicting European bond markets.
Economists at ING said that “there has not been a day, practically ever, where European yields have snapped higher, while Treasury yields barely budge”.
Merz is seeking a constitutional amendment that will exempt defence spending from his government’s tight debt rules – known as the ‘debt brake’ – that have been an integral element of the German economy since the financial crash of 2008.
The plans sent the Dax – Germany’s blue-chip index – up over four per cent on Wednesday, with the rises extended on Thursday morning. But the bond rout infected other fixed income markets across Europe and beyond, with both Australia and Japan’s government yields reaching their highest levels in more than a decade.
Gilt yields rose alongside their European counterparts, in another headache for the Chancellor. 10-year government bonds are now back to where they were in January, when they suffered at the hands of a global sell-off that sent gilts to post-financial crash lows.
Kathleen Brooks, research director at XTB, said: “German spending at this rate and the accompanying jump in bond yields will have a major impact on the ECB.
“Since Christine Lagarde and her predecessors have called for a fiscal response to Europe’s structural issues, this may be welcome news.”