German bond yields jump after Merz elected chancellor, then ease

By Yoruk Bahceli

LONDON, May 6 (Reuters) - German bond yields briefly hit their highest level in three weeks on Tuesday as German conservative leader Friedrich Merz was elected chancellor by parliament in a second round of voting, before paring some of that rise in late trading.

Merz was elected chancellor on Tuesday in a second round of voting after his new alliance with the centre-left Social Democrats was dealt a surprise defeat in the first attempt.

Merz's failure to win parliamentary backing at the first time of asking was a first for post-war Germany and an unexpected setback for his new coalition, which has investors bracing for measures to boost Germany's ailing economy just as tariffs take their toll.

However, the fact "will quickly fade into the background," said Marion Muehlberger, economist and political analyst at Deutsche Bank, as long as the new government quickly implements its 100-day programme with the urgently needed relief for the German economy.

Merz's conservatives and the Social Democrats had already voted to create a 500 billion-euro ($565.75 billion) infrastructure fund and overhaul a constitutional borrowing limit to increase defence spending during the previous parliament's term.

After a limited bond market reaction to Tuesday's surprise, Germany's 10-year yield DE10YT=RR briefly rose as much as 3.7 basis points on the day to a new session high of 2.557% after the second round of voting, its highest in three weeks.

By 1443 GMT, it had retreated somewhat to show a 1-bp rise on the day at 2.53%.

The plans to boost spending are seen as a game changer for Germany's economy and bond markets. Their shock announcement in March pushed German borrowing costs to post their biggest weekly jump since the 1990s and euro zone bond yields rose across the board as investors braced for additional borrowing and stronger growth.

But Germany's borrowing costs dropped sharply in April as investors took refuge in the market as a safe haven amid a searing selloff in U.S. Treasuries driven by tariff fears that raised questions about the status of the world's biggest bond market.

Another focus on Tuesday was debt sales. Germany saw over 47 billion euros of investor demand for a reopening of an outstanding 30-year bond that raised at least 4 billion euros in a syndication, according to a lead manager memo seen by Reuters.

The U.S. will auction $42 billion in 10-year notes. Investors will continue to keep a close watch for any signs of diminishing demand for Treasuries.

Elsewhere, final euro zone business activity data for April showed activity holding up slightly better than initially estimated, with the services sector avoiding a contraction.

($1 = 0.8838 euro)