EURO GOVT-Euro zone bond yields hit new lows on rate cut bets

Tue Apr 30, 2013 6:16am EDT

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By Ana Nicolaci da Costa

LONDON, April 30 (Reuters) - Bund futures neared record highs, while Spanish and Italian borrowing costs fell to their lowest since 2010 on Tuesday as markets expected the European Central Bank to cut interest rates on Thursday.

German Bunds have rallied in recent weeks on expectations of further monetary easing by the ECB, which a narrow majority of economists expect to cut interest rates later this week.

Data on Tuesday only reinforced those bets, analysts said, showing inflation in the euro zone falling to a three-year low and unemployment hitting a new record high..

"To my mind cutting rates is not really the solution, they all know it. It's not going to help lending to southern European companies, it's not going to do much for their economies ... (but) with this inflation number, it's hard to argue against a rate cut," one trader said.

Euro zone inflation dropped to a surprise 1.2 percent in April, the lowest level since February 2010 and the biggest monthly drop in more than four years.

Preliminary data showing Spain's economy - the euro zone's fourth largest - shrank for the seventh straight quarter from January to March also highlighted the plight of the region.

German Bunds were 17 ticks higher at 146.83, closing in on a record high of 146.89.

French 10-year yields fell as far as 1.704 percent, nearly matching last week's record lows.

"We are a bit sceptical that we will keep these (Bund future) levels going into the ECB meeting. We would rather look for a correction but not today, just starting on Thursday," Rainer Guntermann, strategist at Commerzbank, said. He said a 25 basis point rate cut was priced in.

Investors also refrained from taking big positions before a holiday in much of Europe on Wednesday, a two-day Federal Reserve meeting which starts this session, and U.S. jobs data on Friday.

Italian and Spanish government bond yields fell to their lowest since 2010, extending a bond rally made on Monday after Italy clinched a new government, ending months of political deadlock.

"Despite the fact that the periphery is doing well, we are not really trading off it," a second trader said.

The trader expected Cyprus's parliament to approve a bailout imposed by its EU partners without any hiccups, but some analysts were nervous about it.

"An accident would be no majority for the bailout package, refusal of the bailout package. It's not the base(scenario) but it is a risk which is probably a bit under-estimated at the moment," Guntermann added.

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