LONDON: German bond yields fell on Wednesday on expectations that the European Central Bank could hint on Thursday at more monetary stimulus to counter disinflationary pressure from sliding commodity prices.
Growing concern about the health of the global economy after weak Chinese and US economic data and a renewed slide in oil prices also supported underlying demand for top-rated government bonds. Investors fear that reduced consumption from China will exacerbate a fall in oil prices and keep consumer price growth muted, putting pressure on the ECB to expand its 1 trillion euro asset purchase programme targeted to end next September.
The central bank is expected to cut its inflation forecasts at Thursday's policy meeting.
A measure of long-term market inflation expectations watched closely by the ECB fell to 1.68 percent on Wednesday from 1.74 percent on Tuesday, retreating further from the ECB inflation target of just below 2 percent.
"Investors are keenly awaiting (ECB President Mario) Draghi's press conference tomorrow and a lot of investors are not taking major positions ahead of that," said RIA Capital Markets strategist Nick Stamenkovic.
"The likelihood is that he is going to adopt a dovish posture given the rising global headwinds and the market will pay particular attention to the inflation forecasts for 2016 and 2017.
We expect a small downgrade for next year opening the door for an extension of the current QE programme although I don't think Mr Draghi will signal an imminent move tomorrow."
German 10-year yields, the benchmark for euro zone borrowing costs, were 3 basis points down at 0.78 percent, retreating from a two-week high of 0.82 percent hit on Monday after oil prices rallied 8 percent before reversing course. Yields on other top-rated bonds were down a similar amount.
FED CONUNDRUM
US private sector employment data later in the day will be watched to fine-tune expectations for the non-farm payrolls report due on Friday. The labour market report could determine whether the Federal Reserve raises interest rates at its policy meeting towards the end of the month.
The prospects for a September US rate rise have been clouded by the recent rout in Chinese markets and slide in oil prices, which has dampened inflation expectations globally.
"Our house view is that the Fed stays at the sidelines until December," said Rabobank senior rate strategist Richard McGuire.
"I see the risks tilted toward a later rather than a sooner move given the risk the disinflationary forces emanating from emerging markets are likely to remain a thorn in developed world central banks' (side) for some time to come," he told the Reuters Global Markets Forum.
The firmer tone in fixed income and a recent rise supported demand at a German auction of 3.1 billion euros of five-year paper.
Portugal was also seeing strong interest for a sale via syndication of seven-year bonds with orders topping 5 billion euros, according to Thomson Reuters markets information service IFR.
Analysts expect the sale to raise 4 billion euros.
Portuguese 10-year yields edged up 2 basis points to 2.77 percent.
Italian and Spanish 10-year yields were flat on the day at 2.00 percent and 2.15 percent, respectively.
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