Euro zone bonds rally after Fed, ECB also seen dovish

Thu Aug 1, 2013 6:48am EDT

Related Topics

* Euro zone bonds broadly rally after Fed

* ECB expected to reinforce accommodative rate policy stance

* Spanish sale solid, country sells more than targeted amount

By Ana Nicolaci da Costa

LONDON, Aug 1 (Reuters) - Euro zone government bonds rallied on Thursday after the Federal Reserve said the U.S. economy still needed support, with the European Central Bank also expected to stick to its accommodative policy later in the day.

The Fed offered no hint that it is planning to reduce its bond-buying stimulus at its next meeting in September and slightly downgraded its view of the recovery.

The ECB, which holds a monetary policy meeting this session, is expected to reinforce its message that interest rates are on hold for an extended period, even though recent data has shown signs of a tentative recovery in the euro zone.

Reassurances that central bank liquidity would remain abundant pushed euro zone government bonds higher across the credit spectrum, including in Italy and Spain where political risk was reaching crunch point.

"What we are still seeing here is the impact of the Fed statement. Basically what it says is that (the) probability of tapering starting in December has increased versus September, so an overall dovish statement by the Fed," Elwin de Groot, senior market economist at Rabobank said.

German Bunds jumped 80 ticks to 143.17, having reached a session high of 143.24 after breaking above a key technical level at 143. Ten-year German yields fell 6.8 basis points to 1.61 percent.

Yields on bonds issued by other highly rated euro zone countries including Austria, France, Belgium and the Netherlands fell by about 5 to 6 basis points.

Ten-year Spanish yields were 2.5 bps lower at 4.60 percent as Spain sold bonds, while the Italian equivalent fell 4 bps to 4.38 percent.

Spain sold 3.2 billion euros ($4.25 billion) of three- and five-year debt, more than the targeted amount, as the auction was supported by large redemption this week. Investors ignored a growing political corruption scandal which saw the prime minister defend himself to parliament.

"They (domestic investors) need to support their own market because it is against their interest not to," Marc Ostwald, strategist at Monument Securities, said when asked why investors were still snapping up the bonds despite rising political risk.

"There is some optimism that one can sink back into a sense of complacency for this month at least until we get to the bigger hurdles which appear in September."

Spanish Prime Minister Mariano Rajoy acknowledged on Thursday he had made a mistake in his handling of a major corruption scandal in the ruling centre-right People's Party, but vigorously denied he or other party leaders had received illegal payments.

In Italy, the Supreme Court is expected to rule on whether former prime minister Silvio Berlusconi should have his conviction for tax fraud upheld, a case that could destabilise the fragile coalition government.

"There is political risk out of both Italy and Spain and I think there is bailout risk out of both Greece and Portugal," the trader said. "Periphery looks potentially in a mess. I think things have maybe been kept a little bit quiet until we get the (German) elections out of the way and then things blow up."

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