Euro zone bond yields edged up on Wednesday after comments from Russian President Vladimir Putin appeared to open a way to resolving the standoff over Ukraine and as Germany found scarce demand for five-year debt at an auction.
Putin called on separatists in east Ukraine to postpone a referendum on independence for the mostly Russian-speaking region and said Moscow had withdrawn troops from the border with Ukraine.
A NATO official said, however, that there was no indication that Russian military forces were withdrawing.
Nevertheless, Putin's comments took the shine off German Bunds, which investors see as one of the safest instruments in the world.
They also knocked back lower-rated bonds, which since the start of the Ukraine crisis have been sought as a safer alternative to equities. At the height of the euro zone debt crisis two years ago, peripheral bonds would sell off in periods of increased geopolitical stress.
"It looks like the conflict might be easing off a bit so bonds are suffering," one London-based trader said.
German Bund yields , the benchmark for euro zone borrowing costs, rose 1.5 basis points to 1.475 percent, coming off 11-month lows of 1.44 percent hit earlier in the day. Most other yields in the euro zone were 1-3 bps higher, with Spanish, Irish and Italian yields bouncing off record lows.
Another blow for the bond market was a German auction of five-year debt which drew fewer bids than the amount on offer.
The auction result was taken as a signal that many in the market thought yields had fallen too much, especially ahead of a European Central Bank meeting on Thursday which is unlikely to deliver any new monetary policy easing measures.
Five-year debt has historically been more sensitive to central bank expectations than shorter- or longer-term bonds.
"The auction was a big surprise. It seems that the market is getting pretty tired at these levels," said David Schnautz, rate strategist at Commerzbank in New York.
Although no major ECB moves are expected on Thursday, markets are still pricing in some form of easing later this year, as suggested by longer-term money market rates trading below short-dated ones.
Low inflation, a stubbornly strong euro and some recent volatility in interbank lending markets are all reasons for the ECB to consider further easing. Some in the market even argue a move to print money by buying assets - so-called quantitative easing - could be on the cards.
"The ECB is unlikely to announce QE tomorrow because the meeting comes so close to the European Parliamentary elections. June seems more likely, but the ECB is not finding it easy to agree on a QE programme and may need longer still," said Ben Bennett, a credit strategist at Legal & General.
