German yields edge up before two-year bond auction
* Yields firm on expectations of more ECB policy easing
* Emerging market woes increase lure of safe-haven assets
By Marius Zaharia
LONDON, Feb 12 (Reuters) - German government bond yields edged up on Wednesday before an auction of new two-year debt, which is expected to be supported by continuing expectations of further European Central Bank policy easing.
The ECB kept interest rates unchanged at its February meeting, but left the door open to further policy easing in coming months as inflation unexpectedly slowed to 0.7 percent in January, compared with a target of nearly 2 percent.
Short-dated debt is usually more sensitive to shifts in monetary policy than longer-dated debt and demand for such paper is a significant indicator of market expectations regarding the central bank outlook.
"If we get a very strong auction it would be a clear indication that the market expects either a cut in the deposit facility rate or in the (refinancing) rate," said Alessandro Giansanti, a rate strategist at ING in Amsterdam.
Germany is offering close-to-zero returns at the auction, where it plans to raise up to 5 billion euros.
Two-year Schatz yields were 0.5 basis points up at 0.113 percent, with traders saying investors were making room in their portfolios for the new paper.
Yields are now slightly above a 2014 low of 0.065 percent hit at the end of January right after the inflation data, but it is less than half where they ended last year.
Those levels are below one-week or one-month money market rates, for instance - an unusual yield curve inversion which some analysts say suggests market expectations of further ECB easing are embedded in market prices.
GERMAN SAFE HAVEN
"If you look at the shape of the curve, it can mean two things: markets expect the ECB to add more liquidity to the banking system or they expect another... rate cut," said Jussi Hiljanen, chief fixed income strategist at SEB in Stockholm.
But Ralf Umlauf, an analyst at Helaba Landesbank Hessen-Thueringen, doubted short-end rates could be read that way.
"In the wake of the financial crisis, the rules have changed. Those who trade in money markets are different to those who trade the Schatz and I think the safe-have status of German bonds is still depressing yields," he said.
Umlauf said recent flows into top-rated assets were caused by tensions in emerging markets, where on Tuesday the Kazakh central bank devalued the tenge currency and the Nigerian naira hit two-year lows against the dollar.
At the height of the euro zone crisis in mid-2012 when Spain was widely expected to request a bailout and concerns about Greece leaving the currency union reached their zenith, two-year German yields were negative.
That meant investors effectively paid Germany to keep their money for two years, suggesting they were more interested in getting most of their money back on their investment than in any return on it.
Analysts say another major shock would be required to push two-year yields deep into negative territory.
Citi strategists see yields hitting zero in coming quarters, "based on ... (the) expectation that the ECB will cut the refi rate to zero by mid-2014".
Annalisa Piazza, a market economist at Newedge Strategy in London, said another factor that should support Wednesday's auction was the fact that Germany planned to cut its annual two-year bond issuance by 8 billion euros this year.
Ten-year German Bund yields, the benchmark for euro zone borrowing costs, rose 1.5 bps to 1.695 percent.