Euro zone yields fall as ECB rate-cut talk grows

LONDON: Euro zone government bond yields fell across the board on Tuesday, on growing expectations that the European Central Bank will cut its deposit rate next month just as the U.S. Federal Reserve looks likely to hike.

A consensus is forming at the ECB to take the interest rate it charges banks to park money deeper into negative territory, possibly by more than the 10 basis points that markets currently expect, Reuters reported on Monday.

Talk of a further cut to the ECB's -0.2 percent deposit rate helped euro zone yields unwind a rise that followed Friday's strong U.S. jobs data. The data had been seen as easing pressure on the ECB to deliver more stimulus since the euro weakened against the dollar.

But now "we have had this story which suggests a big deposit rate cut seems to be what is most in mind," said Owen Callan, senior analyst at Cantor Fitzgerald.

"It seems the market overdid it in terms of the reaction to non-farm payrolls last week and that people are realising that the ECB is likely to do something in December."

The benchmark 10-year Bund yield fell 5 basis points to 0.63 percent, down from Monday's eight-week high of 0.72 percent.

Two-year yields fell back towards record lows of -0.35 percent hit two weeks ago, helping keep the gap with U.S. Treasuries close to the widest levels in nine years.

Comments from ECB governing council member Erkki Liikanen on Tuesday supported expectations for further monetary stimulus, analysts said.

Liikanen said the euro zone's inflation and growth prospects face downside risks, adding the ECB is "willing and able" to act to achieve its price growth target of close to 2 percent.

"It seems now that you might have a full divergence on the cards in December, with the Fed hiking and ECB cutting rates," said Commerzbank strategist Benjamin Schroeder.

"We still think the ECB might still not cut but we might have to think again about that."

The ECB meets on Dec. 3, with the Federal Reserve scheduled to meet on Dec. 15-16.

Ten-year euro zone government bond yields fell between 4 and almost 12 bps, with Portuguese yields retreating from a four-month high hit on Monday even as leftist parties agreed to formalise a deal to oust the centre-right in a vote scheduled for Tuesday.

Spanish bond yields fell almost 12 bps to 1.88 percent .

"Today's recovery in prices has to do with the market taking a break from yesterday's sell-off and the possibility of the ECB moving in December, which is providing a floor for the periphery," said BBVA chief strategist Pablo Zaragoza.