German yields close to 1-1/2 year highs before ECB meeting
* Bund yields within touching distance of 1-1/2 year highs
* ECB expected to keep soft tone, action seen unlikely
* Spanish, French debt auctions expected to go smoothly
By Marius Zaharia
LONDON, Sept 5 (Reuters) - German bond yields rose close to 1-1/2 year highs on Thursday before a meeting of the European Central Bank, which is seen having little options of tempering a rise in market rates amid an improved economic outlook.
Markets appeared to have cast aside worries about Syria for the moment even as a possible U.S. military strike moved one step closer after a Senate committee voted in favour of action.
This has cleared the way for a vote in the full Senate, likely next week, but the House of Representatives also has to clear the measure, meaning the move was not imminent and flows into low-risk assets such as Bunds partly reversed.
The ECB is facing higher rates at the longer end of the money market curve than before July, when it took the unprecedented step of promising to keep interest rates low for a long time.
The forward guidance was aimed at curbing the impact of prospects of reduced global central bank liquidity, with the Federal Reserve expected to start trimming monetary stimulus in the United States later this month.
Since then, however, forecast-beating euro zone data has renewed rising pressure on money market rates, which filtered through to longer-term maturities on the benchmark German yield curve, reflecting the fact that investors have brought forward expectations of a rate hike.
Tighter market conditions might create discomfort within the ECB, analysts say, as they threaten the euro zone recovery.
But with the ECB failing to agree on cutting rates in July, when they had "extensive" talks about it and when the economic outlook looked worse, analysts see little options for the bank other than just maintaining a soft tone in communication.
"(Draghi) will talk dovishly, but I think his attempts to keep a lid on ... rates will prove difficult given the Fed outlook and the improvement in the euro zone economy," RIA Capital Markets strategist Nick Stamenkovic said.
German 10-year yields rose 3.1 basis points to 1.967 percent, within a whisker of the 1-1/2 year high of 1.98 percent hit last month. Bund futures fell 34 ticks to 139.39.
"It will be interesting to see how (ECB President Mario Draghi) handles it given the economy is improving, but we're expecting more of the same," one trader said. "Maybe the front end is insulated, but everything else seems a bit heavy."
Before the ECB meeting, Spain plans to issue up to 4 billion euros in five- and 10-year bonds, while France sells up to 8.5 billion of long-term bonds in auctions which are expected to go smoothly.
The yield gap between Spanish and Italian 10-year bonds shrank to its tightest in 1-1/2 years of 2 bps last week due to the risk that a looming vote on whether to expel Silvio Berlusconi from Senate could bring down the government.
Supply pressure in Spain saw the spread widening back to about 10 bps, but some analysts expect the move to reverse once the auction is out of the way.
"The auctions should pave the way for 10-year SPGBs(Spanish bonds) trading flat to Italy and 10-year OATs (French bonds) trading tighter again versus Bunds," Commerzbank strategists said in a note. (Reporting by Marius Zaharia and Chris Pizzey, London MPG Desk, +44 (0)207 542-4441)
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