European Shares Hold Steady as Caution Prevails

Reuters

European shares inched down, yields on safe-haven German bonds rose and the euro flatlined on Wednesday as worries about contagion from Spain's banking crisis and this weekend's critical Greek elections kept investors on the defensive.

Asset markets have fluctuated all week as optimism and disappointment have alternately gripped financial markets, reflecting a high level of unease over whether Spain's problems could affect Italy, and if Greece will remain in the euro zone after its June 17 election.

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"There is a risk that the Spanish problems could spread to Italy, and investors are mindful of that," said Jeremy Stretch, head of currency strategy at CIBC World Markets.

The euro was little changed at $1.2522, close to the middle of a range between its two-year low on June 1 at $1.2288 and a three-week high reached on Monday at $1.2672.

Yields on normally safe German bonds rose, however, in a clear signal that some investors are becoming more gloomy about the outlook for the euro zone and the impact it may have on the creditworthiness of the region's largest economy.

German debt has been a big repository of safe-haven flows out of equities, sending returns on offer to record lows, but bond yields were rising on Wednesday, with 10-year Bunds up 8 basis points to 1.5 percent and back to their highest level since late May..

Meanwhile, tension was easing in the peripheral European bond markets, though yields on Italian and Spanish government debt remained at elevated levels of around 6.11 percent and 6.7 percent, respectively .

The cost of insuring Spain's debt against default also eased back from record highs posted on Tuesday, though the rate remains at extremely elevated levels.

"It's just a day of consolidation after the severe widening we've seen over the past few days," said Gavan Nolan, an analyst at CDS data monitor Markit.

"Overall the mood is one of caution ahead of the Greek elections on Sunday."

Five-year credit default swaps (CDS) on Spanish government debt fell 10 basis points to 593 basis points, which means it costs $593,000 annually to buy $10 million of protection against a Spanish default using a five-year CDS contract.

Italian CDS, which have been closely correlated with Spain over recent sessions, also fell, but Italy's one-year borrowing costs shot up from a month earlier at auction on Wednesday.

Italy paid a six-month high of 3.972 percent for one-year funds, compared with the 2.34 percent it paid a month ago for debt with the same maturity.

The country faces a stiffer hurdle on Thursday when it will auction up to 4.5 billion euros of new debt.

GREEK FEARS

Concerns over the outcome of Greek elections at the weekend, where parties opposing and supporting harsh austerity measures imposed by the country's international lenders are neck and neck in public opinion polls, was keeping a lot of investors on the sidelines.

The FTSE Eurofirst 300 index of top European shares, which had opened higher, fell 0.3 percent to 987.44 points, having risen 0.7 percent on Tuesday.

However, the overriding nervousness in the market was highlighted by a 0.5 percent rise in the Euro STOXX Volatility index.

A choppy trading session in Asia earlier left the MSCI world equity index up 0.2 percent at 301.95 points for a gain of around 3.5 percent from last week's lows for the year.

Global growth worries stemming from the problems in Europe were also heightened after an influential Chinese government adviser in China said the country's annual economic growth rate could fall below 7 percent in the second quarter if weak activity persists in June.

The forecast by Zheng Xinli, a former deputy director of the Chinese Communist Party's policy research office, is among the most bearish by any government and private sector economists.

Commodity markets, in tune with other riskier assets, were mostly subdued by uncertainty over developments in Europe.

Brent crude gained 3 cents to $97.17 a barrel, while U.S. crude fell 41 cents to $82.91, reversing its gains of the previous session.

Gold perched above $1,600 an ounce on Wednesday, retaining most of its gains from the previous session, supported by its increasing use as a safe-haven asset.