LONDON: Low-rated euro zone bond yields slipped on Monday, as plunging oil prices bolstered expectations the ECB will soon do more to stimulate the region's economy, including purchasing sovereign bonds.
Oil's fall to 5 1/2-year lows has served to justify bets the ECB will take steps to fight off deflation, which swap rates signal could set in over the next year. Two-year inflation swaps are dangerously close to zero.
Investors snapped up Italian, Spanish and Portuguese bonds, which yield more than their German equivalents and are expected to outperform if the ECB introduces quantitative easing.
Even Greek yields fell, despite being shaken by political jitters in recent weeks.
"If the oil price shifts medium-term inflation expectations, it just increases the prospect of more ECB easing," said Anton Heese, co-head of European interest rate strategy at Morgan Stanley.
Economists polled by Reuters last week were near unanimous that the ECB would begin buying sovereign bonds within a few months.
Italian and Spanish 10-year yields -- considered bellwethers for the bloc's fragile southern periphery -- were down 3-4 basis points at 2.03 and 1.84 percent, respectively.
The German equivalents were up around 2 bps at 0.64 percent. France's were among the worst performers, up 3 bps at 0.93 percent, after Fitch cut the country's credit rating to AA from AA+ on Friday.
The ECB's preferred measure of how the market reads the inflation outlook - the five-year, five-year breakeven forward - hit a record low of around 1.68 on Monday.
But one of the central bank's top policymakers stressed that members are not pre-committed to sovereign bond buying and would have to take account of the overall economic situation.
The ECB is particularly interested in whether a fall in oil prices will prop up domestic spending in the euro zone, which some say could influence this month's preliminary factory and services output data due on Tuesday.
"We look for modest improvement in the composite reading on the back of a combination of lower oil prices and weaker exchange rate contributing to an improvement in confidence," said RBC in a note to clients.
Before that, the ECB will announce its weekly asset purchases later on Monday afternoon.
With tepid demand for the ECB's bank loans last week, the running expectation is the central bank will need to expand this purchase scheme to boost its balance sheet by a planned one trillion euros.
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