Investors shun auction of German Bunds

Fears that governments may not be able to fund their vast borrowings over the next few years without a rise in interest rates were fuelled yesterday as a major auction of German government bonds failed.

The German authorities only managed to sell two thirds of the €6bn (£5.4bn) of 10-year maturity securities that they offered to the market. "I would call this a failed auction," said David Keeble, head of fixed-income strategy in London at Crédit Agricole. "There was no doubt that this was a very poor start of the auction season."

The news triggered a steep fall in the prices of German government bonds, or Bunds, and a corresponding jump in their long-term yields.

Even though yields for shorter-term Bunds (two years) remain low, indicating confidence in the paper issued by the German government in the short term, worries about escalating state borrowings, and increasing chatter about "quantitative easing" or printing money, has shaken investors' confidence that inflation will stay low.

Thus, the German Bund yield curve has steepened considerably, and the differential between two and ten-year rates is at a five-year high. The German auction was the first eurozone government debt supply of the year. The omens for a similar French auction today and for Spanish, Irish, Dutch and Austrian auctions later in the week, are not encouraging, though a UK auction of 30-year gilts did proceed successfully yesterday.

It took place against a background of speculation that Gordon Brown is at odds with the Bank of England over a policy of "printing money" as interest rates approach zero. The Bank's Monetary Policy Committee is almost certain to cut rates today to below the current 2 per cent, taking them to their lowest in the Bank's 315-year history, possibly as low as 1 per cent.

But the Bank of England, and the European Central Bank, may be unwilling to push rates lower if they take the view that government plans to, for example, buy "toxic" debt from the commercial banks are pushing too much money into their economies.