LONDON: A rally in peripheral euro zone government bonds faltered on Tuesday, lifting safe-haven German Bunds as scepticism over the European Central Bank's ability to take bold action to back up a pledge to protect the euro set in.
Spanish and Italian bond yields, which fell sharply after ECB President Mario Draghi said last Thursday the central bank was ready to do whatever it took to safeguard the euro, edged up and were seen drifting higher before the ECB meets on Thursday.
Draghi's remarks sparked expectations that the central bank would revive its bond purchase programme, mothballed for months and opposed by the Bundesbank, at its Thursday meeting to bring down elevated Spanish and Italian borrowing costs.
He also prompted speculation that the euro zone's temporary EFSF rescue fund could start buying Spanish debt but Madrid poured cold water on that on Monday, saying it had no intention of asking for European funds to buy its debt.
German Bund futures were last up 30 ticks at 143.69, having fallen 125 ticks in the aftermath of Draghi's comments. Gains were helped by month-end buying when some investors such as pension funds typically buy to keep their portfolio in line with bond indexes.
German 10-year cash yields were 2 bps lower at 1.35 percent.
"There's a bit of scepticism and wondering if maybe Draghi overpromised. Thursday is going to be very interesting to see what's actually said," a trader said.
"The risks for disappointment for the periphery are quite high if we don't see anything particularly substantial from the ECB and we could see the sharp fall in yields reverse."
Spanish 10-year yields were last 4 bps up at 6.67 percent. They fell almost a full point in recent days from euro era peaks of 7.7 percent hit early last week, as hopes of ECB intervention grew. Equivalent Italian yields were up 3 bps at 5.06 percent.
A resumption of the ECB's bond buying programme could see the 10-year Spanish yield premium over German Bunds tumble over a full point in coming days to 450 bps, ING rate strategist Alessandro Giansanti said. Any disappointment would lead to another blow-out in yields.
Some analysts said Spain's reluctance to apply for EFSF aid, after an already agreed bailout for its banks of up to 100 billion euros, compromised the ECB's ability to act decisively. Previous action by the central bank to buy government debt had had only a limited impact in keeping Spanish yields at sustainable levels.
"There is a potential for large spread compression near term on the reactivation of the SMP (ECB bond buying programme)," RBS strategists said in a note.
"But the effect will dissipate without a memorandum of understanding (on an EFSF aid request from Spain) and as soon as the Bundesbank talks (ECB bond buying) down, so it is likely not long-lived."
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