LONDON: Greek bond yields rose on Monday as investors reacted nervously to signs the euro zone's dominant economy Germany will take a tough stance towards the fiscal commitments the next government in Athens will inherit from its predecessor.
Greeks go to the polls on Jan. 25 in a snap election that could lead to a government headed by the leftist Syriza party, which has said it wants to cancel the austerity measures the country has taken in return for 240 billion euros of bailout loans from the European Union and the International Monetary Fund.
The ability of Athens and Berlin to reach a compromise under such a scenario could determine Greece's future in the euro zone, some analysts say. Der Spiegel magazine cited unnamed government sources on Sunday as saying Germany believed the euro zone would now cope with a Greek exit.
Germany's Vice Chancellor Sigmar Gabriel said later that Berlin wanted Greece to stay in the euro zone but expected the next government to abide by the terms of the bailout.
Greek 10-year bond yields were 21 basis points higher at 9.46 percent.
"Until the political solution and the funding options for this year become clearer ... investments in Greece remain very high risk," said Commerzbank rate strategist Christoph Rieger.
Political turmoil in Greece was triggered after parliament rejected Prime Minister Antonis Samaras' nominee for president last week.
It could now also complicate a debate within the European Central Bank over launching a bond buying programme, said Gary Jenkins, chief credit strategist at LNG Capital.
"How could the ECB commence a programme that included the purchases of Greek government bonds when the potential new government would probably be demanding a haircut on its debt held by such institutions? At the same time, how could the ECB start such a programme and exclude Greece?," he said.
One possible solution could be for the ECB to ask national central banks to bear more of the risk and cost of printing money. ECB officials told Reuters last month that central banks in low-rated countries could be asked to set aside extra money or provisions to cover potential losses from any bond-buying.
"They will be very cautious to buy Greek bonds," said Lauri Haelikkae, fixed income strategist at SEB. "It makes things a bit more difficult but I don't think that will stop the ECB."
NO INFLATION, NO CONTAGION
The strong start to the year in other euro zone bond markets suggests investors largely expect the ECB to keep its focus on inflation - and possible further stimulus measures to boost it - rather than regional politics.
ECB President Mario Draghi said in an interview published at the start of the year that the risk of the central bank not fulfilling its mandate of preserving price stability was higher now than half a year ago, and reiterated his readiness to act.
Germany's harmonised inflation for December is expected later on Monday to show a fall to 0.2 percent on the year from 0.5 percent in the previous month, likely paving the way for a negative inflation figure for the entire single currency area on Wednesday.
On Monday, ten-year German yields were a touch up at 0.51 percent, after falling 5 basis points on Friday to a record low of 0.493 percent. Other euro zone yields were 3-4 bps higher after falls of 10-25 bps on Friday.
But they remained close to their troughs, with Spanish 10-year yields trading around 1.50 percent, Italian yields just below 1.80 percent and Portuguese yields at 2.50 percent.
"Inflation figures in Germany will probably be very low and ... will confirm that quantitative easing is very close," said KBC strategist Piet Lammens, using the specialist term for a central bank asset purchase programme.
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