Euro zone yields fall after ECB's Draghi flags possible LTRO

Mon Sep 23, 2013 12:18pm EDT

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* Irish debt premium hits lowest since May 2010

By Ana Nicolaci da Costa and Marius Zaharia

LONDON, Sept 23 (Reuters) - Euro zone debt yields fell on Monday after European Central Bank President Mario Draghi flagged the possibility of another round of cheap loans to banks keep monetary policy loose.

Draghi told the European Parliament's Economic and Monetary Affairs Committee the ECB was ready to use any instrument, including another long-term refinancing operation if needed, to keep short-term money market rates at a level warranted by its assessment of medium-term inflation.

The ECB has already injected more than a trillion euros through two such operations, in December 2011 and February last year, to support bank lending and avert a credit crunch.

Analysts had expected the U.S. Federal Reserve's decision to leave its bond-buying programme untouched last week to have eased the pressure on the ECB for more monetary stimulus.

"We have had comments from Mr. Draghi hinting there could be further support for the banks," Nick Stamenkovic, bond strategist at RIA Capital Markets said.

"To mention the LTRO per se clearly shows they could be concerned about the pay-down of LTROs by quite a few banks and the damage that's doing to liquidity...It also clearly shows that the ECB is still very cautious about the economic outlook in euroland."

The excess liquidity held by euro zone banks last stood at 221 billion euros. At 200 billion, market rates have historically started to rise.

Ten-year German yields fell 3.6 basis points to 1.87 percent and Bund futures pushed higher. Dovish comments from Federal Reserve officials were also supportive, traders said.

Riskier euro zone bonds also rose, with 10-year Italian yields falling 2.3 bps to 4.27 percent and the Spanish equivalent falling 3 bps to 4.28 percent.

Money market traders expect the ECB to inject more liquidity into markets through another three-year LTRO within the next 12 months, a Reuters poll showed on Monday.

IRELAND

Ireland's debt premium fell to its lowest in almost 3-1/2 years after Moody's moved a step closer to restoring the country's investment grade ratings months before its exit from its 85 billion euro bailout programme.

Moody's is the only one of the three big agencies to class Ireland as "junk", but its move to lift the rating outlook to stable from negative came against a trend of mostly negative rating actions against euro zone sovereigns in recent years.

Losing junk status may further improve sentiment towards Ireland but market reaction may be limited as the move was expected to trigger little buying by index-tracking bond funds.

Ireland's rating excludes it from just one major index, JPMorgan's EMU Government Bond Investment Grade Index, which is only tracked by 3-5 billion euros of bond funds. Irish bonds would have only a 1.6 percent weight if they were included.

"The element of surprise is (also) lacking. Ireland is already perceived as the strongest of the peripheral countries so it's understandable the market is not going crazy about (its ratings), DZ Bank rate strategist Christian Lenk said.

The 10-year yield gap between Irish bonds and their German equivalent narrowed to 193 bps and down from euro-era highs of over 1,200 bps. The spread, however, was slightly wider on the day by late trade at 202 bps as Bunds outperformed.

Euro zone debt showed a muted reaction to Chancellor Angela Merkel's winning a third term in Sunday's German elections, with investors keen to see the shape of the new government before assessing how it will affect European policy.

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