LONDON: German Bunds held steady on Thursday as deflation worries in the euro zone, underscored by figures from Spain, offset the impact of the U.S. Federal Reserve ending its bond-buying programme with a positive note on the economic outlook.
Spanish consumer prices fell 0.2 percent in October compared with a decline of 0.3 percent in the previous month. While in line with expectations, the fact that the figure held below zero reinforces bets that the European Central Bank may have to ease monetary policy even further.
On the other side of the Atlantic, the U.S. central bank dropped a reference to labour market slack as "significant", in a show of confidence on the economy.
It also largely dismissed recent market volatility, dimming European growth and low inflation as unlikely to undercut progress towards its unemployment and inflation goals.
As a result, yields on U.S. Treasuries rose roughly 4 basis points on Wednesday, while short-term interest rate futures suggested markets had brought forward their Fed rate hike expectations to September from October next year.
German 10-year Bund yields, which often take their cue from moves in U.S. Treasuries because both share a safe-haven benchmark status, did not replicate the move. They were last a fifth of a basis point higher at 0.895 percent.
"The Bund market is focused on the ECB and the outlook for the euro zone recovery," said Alessandro Giansanti, senior rate strategist at ING.
The ECB has just launched a programme of buying covered bonds and asset backed securities, and several sources have said it is considering buying corporate bonds to inject more money into the sluggish economy. Many in financial markets expect the ECB to eventually start buying government bonds.
German inflation data is due at 1300 GMT, and expected to show a 0.9 percent rise, which should contribute to an overall figure for the euro zone of 0.4 percent, well below the ECB's target of just below 2 percent.
Figures for the region are due on Friday at 1000 GMT.
ITALIAN PREMIUM
Italy said it would issue up to 7.25 billion euros of floating rate notes linked to euro zone inflation, as well as five- and 10-year conventional bonds.
News that nine Italian banks failed the ECB's stress tests pushed the premium Italian 10-year bonds offer over their Spanish counterparts to its highest since February 2012 at 40 bps earlier this week.
Italian 10-year yields were up 2 basis points at 2.52 percent on Thursday, while Spanish yields were flat at 2.14 percent, leaving the gap between the two at 38 bps.
All Spanish banks passed the health check. Rome has also been criticised for the slow pace of the economic reforms needed to boost growth and ease a 2 trillion euro debt burden.
While Italy's economy is in recession, Spain's expanded by 0.5 percent in the third quarter, data showed on Thursday.
The level of demand at the auction will be scrutinised for any signs on whether investors consider that the yield premium over Spain attractive enough. Commerzbank strategists prefer Italian bonds over Spanish ones at these levels.
"Today's offering may give a clue to how much further this widening trend can run, though we suspect the move has gone beyond the fundamental differences of the two sovereigns," said Orlando Green, rate strategist at Credit Agricole.
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