LONDON: Euro zone bond yields traded around record lows on Tuesday as market participants became increasingly convinced that weak euro zone growth and inflation would push the ECB to implement a broad-based asset purchase programme.
ECB President Mario Draghi hinted as much late Friday at a central bankers meeting in Jackson Hole, specifically citing the recent fall in the markets' inflation expectations. For some investors, returning after a British bank holiday, Tuesday presented the first opportunity to respond to his comments.
"If it is confirmed over the next few weeks and months that inflation goes closer to zero, they (ECB) will have to buy everything they can and inflate the balance sheet. There is no other option," said Frederik Ducrozet, senior euro zone economist at Credit Agricole.
German 10-year yields -- the euro zone benchmark -- were 2 basis point lower on the day at 0.935 percent, just above the record low of 0.926 percent hit Monday.
Strategists said a raft of looming U.S. data, which could firm up the case for the U.S. Federal Reserve to raise rates, was keeping investors on their toes.
While disappointing euro zone growth and inflation has pushed the ECB towards radical policy action, a rebounding U.S. economy is pushing the Fed in the opposite direction. Any move to raise U.S. rates would ripple across global markets, and could make current low Bund valuations hard to justify.
"For today, we see risks of a setback prevailing ... finding yields at record lows while stronger U.S. macro data is waiting in the wings," said Commerzbank in a morning note.
Commerzbank specifically referenced July's U.S. durable goods data, which they say could have jumped as much as 20 percent in July. Economists polled by Reuters expect a 7.5 percent increase.
Low-rated euro zone government bonds outperformed their peers, with Spanish, Italian and Portuguese bonds all hitting fresh record lows.
Strategists said it was not only Draghi's receptiveness to further monetary easing on Friday that buoyed markets, but what appeared to be a general shift in policy towards growth from austerity.
In his speech, Draghi urged governments to push ahead with structural reforms, such as making labour markets more flexible.
The ECB's governing council will meet next week although with a new series of emergency loans due to be released later this month, it will likely be too early for new measures. Meanwhile the bloc's latest inflation data due out on Friday will be closely watched.
Elsewhere, France's 10-year yields were 3 bps lower at 1.29 percent, after French President Francois Hollande on Monday called for a cabinet reshuffle.
The move has been welcomed by economists, who were glad to see the removal of leftist ministers who had argued for an economic policy U-turn away from budgetary rigour.
Strategists said the reshuffle has also helped raise the prospect of an asset purchase programme, widely known as quantitative easing.
"French fiscal laxity is a threat to QE because it could stoke German opposition," said Lyn Graham-Taylor, fixed income strategist at Rabobank.
In other news, Greek bonds dropped 8 bps to 5.65 pct after Reuters reported the country plans to offer a bills-for-bonds debt swap in the coming weeks to top its three- and five-year bond issues by as much as 1.5 billion euros.
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