LONDON: German bond yields rose to their highest level in almost four months on Monday, facing upward pressure from a rise in U.S. and British bond yields as focus turned to an ECB meeting that could shed more light on the central bank's bond buying programme.
A report last week that the European Central Bank may discuss technical changes at this week's meeting that would allow it to extend the 1.7 trillion euro asset purchase beyond the March 2017 end-date had bought some relief to markets unnerved this month by talk of a "taper."
Bond yields across the region have risen since the ECB last met in early September, with more offering a yield above the bank's eligibility threshold. That creates some space for the central bank, which faces a scarcity of eligible bonds for quantitative easing.
Germany's benchmark 10-year bond yield has risen 20 basis points this month, moving out of negative territory.
It rose more than 3 basis points to 0.095 percent on Monday, its highest level since June as U.S. bond yields rose following a suggestion by Federal Reserve Chair Janet Yellen that the central bank may allow inflation to exceed its 2 percent target.
A further rise in British gilt yields helped push euro zone yields 3-4 bps higher on the day.
Commerzbank estimates that the ECB will run out of eligible German sovereign and agency paper to buy by next summer, about three months later than last month when yields were lower.
Analysts expect the ECB to keep policy unchanged this week and wait until December to unveil a possible extension and tweaks to the programme.
Still, the ECB's news conference with President Mario Draghi will be scrutinized closely as investors assess both the scope for further easing and eventual tapering.
"Rhetoric will be very important this week," said Martin Van Vliet, senior rates strategist at ING. "Draghi will try to play down the taper talk and may give some hints on what to expect in December."
Most economists do not expect the ECB to start scaling back its massive monetary stimulus soon, but note that a report this month that the ECB might reduce or 'taper' the scale of its purchases before the scheme finally ends has struck a chord.
Market pricing suggests a 10 bps rate cut is priced in by the end of 2017.
TAPER?
Against this backdrop economic data could start to play a more important role in shaping market expectations for what the ECB will do next.
"We think the ECB will declare victory once it becomes more and more certain that inflation is moving about 1 percent and then it will start to prepare markets for tapering," said Shweta Singh, a senior economist at Lombard Street Research.
Euro zone inflation at 0.4 percent is well below the ECB's target of close to 2 percent. It is expected to rise in the months ahead, pulled higher by oil prices.
A key market gauge of long-term inflation expectations, has started to move higher. The five-year, five-year breakeven forward, which measures where the market expects 2026 inflation forecasts to be in 2021, is trading around 1.41 percent -- its highest level since June.
Still, euro zone bond markets are not expected to witness a "taper tantrum" on the same scale as U.S. bond markets experienced in 2013 when former Federal Reserve Chairmen Ben Bernanke first suggested that quantitative easing in the U.S. would be slowly wound down.
The experience of that sell-off, which saw U.S. Treasury yields jump just over 100 bps between May 2013 and early 2014, could weigh on the ECB's mind.
UBS estimates that long-dated yields on core euro zone government bonds will rise by around 70 bps by the time QE is fully tapered.
"With tapering likely to start next year, you will continue to see bond buying throughout 2017," said Mark Dowding, co-head of investment grade, BlueBay Asset Management. "In this environment, German Bunds are going to remain scarce and that will limit how high yields can rise in a material fashion."
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