LONDON: Euro zone government bond yields nudged up on Tuesday as investors paused for breath after the market's sharp rally, with moves seen limited before an ECB meeting this week that could further ease monetary policy.
Investors were also wary of pushing yields any lower before US economic reports that many expect to show the recovery in the world's biggest economy remains on track, in contrast to the grim outlook in Europe.
Euro zone bond yields stayed within sight of historic lows after anaemic manufacturing data from the currency bloc reinforced bets the European Central Bank will deliver more stimulus for a stuttering economy at its meeting on Thursday.
"If the ECB delivers, the market would rally slightly, if not there could be a decent setback not only at the front end (shorter-dated bond yields) but also in the spreads. But going into the Thursday there will be little movement," said Patrick Jacq, a strategist at BNP Paribas in Paris.
Yields on 10-year Italian, Spanish and Portuguese bonds were 2 basis points up at 2.45 percent, 2.28 and 3.22 percent respectively as were those on German Bunds, the benchmark for euro zone borrowing costs, at 0.90 percent.
The German 10-year yields are just off record lows of 0.867 percent hit last week, with the conflict in Ukraine supporting demand for safe haven assets.
QE QUESTION
Two-year yields on top-rated euro zone bonds remained firmly in negative territory ahead of the ECB meeting, with Irish equivalents flirting near zero percent, a sharp turnaround in the fortunes of a country that only exited an international bailout late last year.
Banks including JP Morgan, Nomura and RBS are urging the ECB to cut interest rates this week, with some expecting Draghi to lower the charges on the emergency loans (TLTROs) that will be made available to banks for the first time this month.
Dovish comments by ECB President Mario Draghi in late August sparked market bets that the centrla bank is preparing to pump more liquidity into the system, possibly via a broad-based quantitative easing (QE) asset purchase programme.
Sources from within the central bank told Reuters last week that new action on Thursday was unlikely but not impossible, and that the barrier to QE was still "very high". While most market participants do not expect the ECB to take major easing steps this week, further measures are considered a matter of when and not if in the face of risks to euro zone growth posed by low inflation as well as the Ukraine conflict.
"People in the market have learned from the events of the past few years, we've had two instances when there was a lot of pressure on the ECB and people thought they won't deliver but they did," Lombard Odier global fixed income strategist Salman Ahmed said.
"Now the market has learned that if pushed the ECB will deliver. It's created a reaction function. The market is front running Draghi and it can continue until QE actually happens."
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