LONDON: Euro zone government bond yields rose on Tuesday as investors booked profits from the market's rally, though the moves were expected to remain modest before an ECB meeting this week that could see the bank ease monetary policy.
Investors were also pushing for cheaper prices before a slew of debt sales this week and U.S. economic reports, which many expect will show the recovery in the world's biggest economy remains on track, in contrast to the grim outlook in the euro zone.
Top-rated euro zone bonds underperformed peripheral debt, with yields bouncing off record lows hit last week. Ten-year German, Dutch and French yields were 4 basis points higher at 0.92 percent, 1.10 and 1.30 percent respectively.
Peripheral bond yields were 1-3 bps up, not far from historic lows after anaemic manufacturing data from the currency bloc on Monday reinforced bets the European Central Bank will deliver more stimulus for the stuttering economy at its meeting on Thursday.
"We've had one heck of a rally following (ECB President Mario) Draghi's speech in Jackson Hole and we might be just seeing a bit of a pause for breath," said Nick Stamenkovic, a strategist at RIA Capital Markets in Edinburgh.
"Even if Draghi doesn't announce rate cuts or QE (asset purchases), I think he will open doors to further significant action further down the road and that should be enough to support the market at least for now."
QE QUESTION
Two-year yields on top-rated euro zone bonds remained firmly in negative territory ahead of the ECB meeting, with even 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 the bank 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 Draghi at a central bankers' meeting in Jackson Hole, Wyoming in late August sparked market bets that the central 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," said Salman Ahmed, global fixed income strategist at Lombard Odier.
"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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