EURO GOVT-Auctions stall Bund rally but demand remains solid

Thu Apr 18, 2013 3:50am EDT

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* Bunds steady as market readies for French, Spanish supply

* German rally seen resuming, record high prices in sight

* Italy, Spain in demand as liquidity spurs yield hunt

By William James

LONDON, April 18 (Reuters) - Debt sales due from Spain and France put a cap on German bond prices on Wednesday, but appetite for euro zone bonds was likely to remain high on expectations of looser monetary policy and a hunt for yield.

The combination of increasing positioning for a European Central Bank rate cut, along with an appetite to hold lower-rated but higher-yielding debt has helped bonds across the region to rally this week, with little sign of demand slowing.

"There's a bit of supply to contend with this morning so that may put the brakes on things for now, but the way the market has been trading we should press on here," a trader said, predicting a medium-term drop in 10-year Bund yields to 1.1 percent from their current 1.24 percent.

Demand for German debt was boosted on Wednesday by comments from European Central Bank policymaker Jens Weidmann, who stoked expectations that euro zone interest rates could fall if economic data remains weak.

Bund futures fell 10 ticks to 146.14, but remained within sight of the April 4 high of 146.54. A break above that level would put the contract at its highest level since June 2012 - when Spanish borrowing costs were spiking in anticipation Madrid would need a bailout.

Those fears have been calmed by the ECB's promise to intervene in bond markets if needed, and a flood of liquidity provided by central banks worldwide has helped support bonds across the whole credit spectrum in the euro zone.

"There's just so much money out there, you're seeing a bid for everything," said Lyn Graham-Taylor, strategist at Rabobank in London.

"You're not seeing that simple risk-on, risk-off situation where Spain and Italy do well and Bunds do badly, we're actually seeing everything do well at the same time."

Italian 10-year yields dipped 3 basis points to 4.23 percent, around 50 bps lower since the start of the month, while Spanish yields fell by the same amount to 4.67 percent, close to 14-month lows seen last week.

SUPPLY INJECTION

Spain and France were both due to issue debt later in the session. Both offer higher yields relative to German debt and are likely to draw solid demand.

"The market's persistent rally suggests these treasury offices will have no problem getting investors to take their paper," DZ Bank strategist Christian Lenk said in a note.

Analysts pointed to redemptions and coupon payments due from France and Spain in the coming weeks as another factor supporting the sales.

Spain will sell three-, five- and 10-year debt, targeting between 4 and 5 billion euros, while France seeks up to 9.5 billion euros from sales of inflation-linked and nominal bonds.

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