By Mike Dolan
LONDON, May 28 (Reuters) - European government borrowing
costs jumped to their highest in almost five months on Wednesday
after data showed German inflation accelerating in May, but a
further retreat in sky-high oil prices helped buoy stocks.
U.S. crude prices <CLc1> extended Tuesday's slide below $130
per barrel and fell a further one percent to as low as $126.37
on concerns about the global economic impact of its 30 percent
surge in recent months.
The relief of oil's retreat, which helped boost U.S.
consumer technology stocks <> on Tuesday, also sent
European stocks <> up to one percent higher and took the
edge off bond market losses.
But German bond yields surged earlier after five German
states said annual inflation rates jumped half a percentage
point or more during May, indicating an acceleration in national
inflation to more than 3 percent from 2.4 percent in April.
The alarming inflation news came after Bundesbank President
and ECB policymaker Axel Weber told Reuters on Tuesday that the
central bank must keep open the option of higher interest rates.
"You can forget about an interest rate cut by the ECB this
year. Instead, they're discussing a rate increase," said Stefan
Muetze, an economist at Helaba.
Ten-year German bund yields, which set the benchmark for
euro zone government borrowing costs, rose on Wednesday as high
4.347 percent <EU10YT=RR> -- their highest since Jan. 2.
"People are talking about rate hike expectations in the euro
zone," said Niels Christensen, strategist at Nordea, Copenhagen.
"They (ECB officials) will keep the hawkish stance for the
foreseeable future."
Weakness in German government debt markets was compounded by
poor demand for new 10-year bunds at Wednesday's latest auction,
where the Bundesbank retained more than two billion euros worth
of paper -- almost 30 percent.
"They kept 2.0 billion back, which is a huge quantity; only
getting 7 billion bids in an 8 billion auction is terrible,"
said David Keeble, strategist at Calyon.
Euribor interest rate futures for delivery in the second
half of next year also fell, pushing implied expectations for
euro zone interest rates higher over the long-term horizon.
The German data also lifted inflation expectations. Measured
by so-called breakeven rates between European index-linked, or
inflation protected, bonds and cash bonds, these expectations
spiked to their highest in 4 years, Reuters charts show.
French 10-yr breakeven rates popped up to as high as 2.48
pct, up almost 20 bps in barely over a week and the highest in
at least 4 years. Before credit crunch in Aug last year, the
rate was around 2.05 pct. German 10-yr breakevens jumped to 2.42
pct -- up around 15 bps in a week and highest in two years.
Government bonds around the world have been hit hard in
recent weeks as investors unloaded "safe-haven" positions built
up during the height of the credit crisis and asset managers
shifted back to equities. Benchmark yields on the 10-year U.S.
Treasury note <US10YT=>, for example, jumped about 7 basis
points on Wednesday after a reading of U.S. consumer inflation.
"Demand from developing countries is likely to keep
commodity prices high and the cost of living is set to continue
rising," Percival Stanion, head of fund manager Barings'
multi-asset group. "The mid-part of the economic cycle might
have lasted longer than expected, but we're back in classic
territory for economists: late-cycle inflation."
The euro <EUR=> benefited initially from the German
inflation news but slipped back later as the dollar rebounded
with the fall in oil prices. By 1230 GMT, it was down about
quarter of a cent at $1.5650 <EUR=>.
STOCKS ENCOURAGED BY OIL
European stocks were higher as rallying tech stocks and
consolidation hopes in the insurance sector helped the market
snap a three-day losing streak.
"For the wider European market, falling oil eases
inflationary pressures, though we still have to knock a long way
back from here," said Justin Urquhart Stewart, investment
director at Seven Investment Management.
At 1230 GMT, the FTSEurofirst 300 <> index of top
European shares was up 0.8 percent at 1,324.92 points, rising
only for the second time in seven sessions.
German software maker SAP <SAPG.DE> added 4.3 percent, also
helped by an upgrade from Cheuvreux to "selected list" from
"underperform". The brokerage said in a note the company has
strong cashflows and the stock is undervalued.
Reports of strong interest for the insurance unit of Royal
Bank of Scotland <RBS.L> lent support to insurance stocks, with
Axa <AXAF.PA>, Prudential <PRU.L>, Aviva <AV.L> and Swiss Re
<RUKN.VX> up between 2 and 3 percent.
ASIA CLOUDS
Asian stocks slid earlier, down for the sixth day out of
seven, as a cloudy U.S. economic outlook and lingering inflation
fears left investors skittish.
"While oil prices have eased somewhat, they still remain
high, and volatility in the foreign currency market is
contributing to investors' uncertainty about the macroeconomic
environment," said Lee Kyoung-su, analyst at Daewoo Securities.
Japan's Nikkei share average <> fell 1.3 percent and is
down 10.4 percent this year.
An MSCI index of stocks in the Asia Pacific region outside
of Japan <.MIAPJ0000PUS> fell 0.7 percent, dragged down by the
Australian stock market <>, which sank 1.3 percent on
losses at resource-related companies.
(Additional reporting by Toni Vorobyova, Kirsten Donovan,
Sitaraman Shankar in London, Dave Graham in Berlin and Kevin
Plumberg in Hong Kong, editing by Malcolm Whittaker)
