Euro Rates May Need To Rise More To Attract Demand In 2026

(MENAFN- ING) The record supply in 2026 will be more than the price-insensitive demand

Markets did well to absorb the first wave of issuance in January, but our analysis suggests rates may have to rise further. In 2026, we face a record-high €930bn net supply of European government bonds. Government issuance accounts for around €550bn in 2026, whilst the European Central Bank's Quantitative Tightening (QT) programme is expected to add another €380bn of supply for the market to absorb.

A record amount of government bond supply is set to hit markets in 2026 Price-sensitive vs price-insensitive demand

In our analysis, we distinguish between price-sensitive demand and price-insensitive demand. Price-sensitive buyers will want to see higher yields before they're willing to step in. In contrast, price-insensitive demand is often driven by regulatory frameworks. For banks and pension funds, for example, we see that the demand for government bonds is closely linked to asset growth. This demand is likely to be relatively price-insensitive. On the other hand, investment funds, for instance, are less bound by regulatory frameworks and their demand is more likely driven by yield levels.

A bottom-up sector analysis suggests a demand shortfall of €230bn for government bonds

We estimate the price-insensitive demand for government bonds to be around €700bn, which leaves €220bn to be absorbed by more price-sensitive buying. Banks will continue to be the biggest price-insensitive buyer in the eurozone as they need to replenish the outflow of central bank reserves. But to find additional demand from more price-sensitive investors, like investment funds, yields may have to turn more attractive. This supports our view that 10Y Bund yields will still drift higher and hit 3.1% by the end of 2026. In the following analysis, we dive deeper into each sector's demand drivers.

Banks continue to play a key role in absorbing government bonds

The latest data shows that banks bought around €340bn of government bonds annually and should continue as the biggest buyer in the eurozone. Regulation requires banks to hold High Quality Liquid Assets (HQLA) to cover liquidity outflows, increasing the demand for government bonds. As central bank reserves get withdrawn from the system by QT, banks must replenish their liquidity portfolio with other HQLA to maintain a constant Liquidity Coverage Ratio (LCR). Around 55% of the non-reserves HQLA consists of government bonds. Therefore, replacing the €380bn in reserves will amount to around €210bn in demand for government bonds.

Banks buy government bonds as central bank reserves decrease and assets grow

The amount of HQLA needed to maintain a stable LCR also increases with the balance sheet. And indeed, over time, we see that banks' HQLA as a share of total assets is stable at around 20%. By extrapolating asset growth and changes in central bank reserves, we can model the demand for government bonds. Assets have been growing at a rate of around €1.1tn over the past few years, which amounts to increased demand for government bonds of €120bn.

The total demand of €330bn from eurozone banks will help absorb the significant supply, especially because the purchases will be relatively price insensitive. The demand for government bonds is driven by regulatory constraints and the pool of HQLA alternatives is relatively limited.

The price-insensitive demand for financial investors is estimated by extrapolating trends in asset growth

Insurance corporations are another major investor but may seek steeper curves to ramp up buying. The insurance sector ramped up buying again in 2025, with the latest data showing €49bn of annual net purchases. Before 2021, around 20% of assets consisted of government bonds, but the share is still just 15% currently. This means that the upside is significant, but the chart below suggests insurance corporations are price-sensitive buyers. The buying of government bonds looks linked to the steepness of the 5s30s curve. So whilst we estimate a baseline of €40bn in demand for 2026, higher yields may be needed to see more marginal buying.

Insurance corporations may seek steeper curves to ramp up demand further

The demand from pension funds will be significantly reduced due to the ongoing Dutch pension fund transition, and we even expect the sector to be a net seller in 2026. The relationship between assets and government bond holdings is very stable at around 15% of assets, which would usually result in around €20bn of additional demand. But the Dutch pension reforms trigger a structural decline in government bond demand of an estimated €100bn. A large part of this may only happen in 2027, but already in 2026 we estimate around €30bn of net selling from Dutch pension funds. The overall demand will therefore decline by around €10bn this year. Having said that, pension funds can be quite flexible in increasing their purchases of government bonds, but, of course, this does require attractive yields versus other asset classes.

The biggest potential may come from investment funds, but these are also very price sensitive. The positive correlation between transactions and the 10Y swap rate suggests investment funds simply buy when rates are higher and sell when they are lower. Having said that, as a share of assets, the holdings of government debt securities have stabilised around 5% over the past few years. Under that assumption, another year of 5% asset growth would result in €50bn in additional government bond demand. This may hinge more on equity prices as these make up the largest part of the funds. And again, if yields rise enough, then investment funds may be tempted to rotate more towards government bonds.

Investment funds are a large potential buyer but are sensitive to yield levels Foreign buyers can come to the rescue but fiscal concerns remain a risk

Strong demand from foreign investors could persist as the holdings are still well below the pre-QE era. Before Quantitative Easing (QE), foreign holdings accounted for more than 27% of the total outstanding debt, well above the current 24%. The latest data shows annual demand of €245bn, just behind eurozone banks.

Predicting the demand from foreign investors is more difficult as the investor base can be very diverse. Official FX reserves managers are a key buyer of eurozone government debt and are relatively price insensitive. With the global role of the dollar being challenged, we expect increased demand for euro assets. In our price insensitive demand assumption, we just stick to the latest available flows data.

Other foreign investors, such as private financial corporations, are likely more price-sensitive buyers. This also explains the demand patterns we see around QE and QT. When the ECB purchases large amounts of government bonds, yields are pushed down, driving foreign buyers away. Inversely, during the current phase of QT, foreign investors are tempted back in as yields go higher.

Foreign investors help absorb additional supply from QT

With QT having stabilised at around €350bn per year, we anticipate that foreign buyers will remain a key source of demand in 2026. But that is with the caveat that yields may have to continue rising to sustain these flows. Speculation about de-dollarisation suggests a possible upside surprise in demand for European assets as an alternative. The eurozone is one of the remaining issuers of AAA-rated debt, the safest of safe assets. As the US fails to address its fiscal issues, European debt may look increasingly attractive for those foreign investors seeking safety. The flip side is that parts of Europe also face fiscal challenges, and any fears of another euro sovereign debt crisis could quickly scare away foreign investors.

The majority of global AAA-rated debt is found in the eurozone

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