LONDON: Euro zone bond yields pushed lower on Tuesday after a slump in German investor morale added to concerns about the region's economic recovery, bolstering bets for further policy easing by the European Central Bank.
The ZEW index showed German analyst and investor morale fell to its lowest in more than 1-1/2 years in August, as Europe's largest economy was hit by fallout from the Ukraine crisis.
The survey was the latest snapshot of the impact on the region of economic sanctions between Russia and the West over the Ukraine, which analysts say will hurt an already feeble and uneven euro zone recovery.
The ECB held fire at its policy meeting last week, but its President Mario Draghi cited the tensions between Russia and the West as a threat to growth in the currency bloc, leaving the door open for further supportive action.
"As far as markets are concerned there's been a relapse in economic performance in the euro zone," said Orlando Green, an interest rate strategist at Credit Agricole.
"Given that the ECB still has potentially more... in its toolbox, the market is also seeing that as a sign to keep the bond market elevated because the ECB could do more in terms of loosening monetary policy."
Italian and Spanish 10-year bond yields were 3-5 basis points down at 2.76 percent and 2.50 percent respectively. Peripheral euro zone bonds have been the main beneficiaries of the ECB's policy easing which has driven their yields to historic lows.
A flight to quality that had pushed Bund yields to all-time lows last week began losing some of its steam after Russia stopped military drills on its eastern border with Ukraine. But tension began to build again with a Russian plan to send an aid convoy into eastern Ukraine, supporting underlying demand for assets seen as safe havens.
German Bund yields, the benchmark for euro zone borrowing costs, were a touch lower at 1.06 percent, not far from a record low of 1.024 percent reached last week.
Some in the market expect Bund yields to fall further to a low of 1 percent if the slowdown in euro zone growth is confirmed and if the ECB continues its wait-and-see stance on further policy easing.
"Bunds are not expensive at 1 percent if growth momentum is slowing, whilst the ECB continues to make a policy error of timidity (on further cuts to its main interest rate).... Both conditions need to be reversed for us to sell Bunds and neither seems likely in 2014," RBS strategists said in a note.
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