Euro zone bond yields fall as U.S. manufacturing weakening

Mon Mar 24, 2014 12:58pm EDT

* U.S. factory activity growth slows in March

* Dovish comments by ECB's Liikanen also pull yields down

* Greek bonds extend outperformance (Updates with closing prices, fresh comments)

By Emelia Sithole-Matarise and Marius Zaharia

LONDON, March 24 (Reuters) - Euro zone debt yields fell on Monday after data showed U.S. manufacturing was weakening, leading investors to buy back some of the bonds they sold when the Federal Reserve signalled it may raise rates sooner than expected.

Fed chair Janet Yellen surprised markets last week by saying the U.S. central bank would probably end its stimulus programme this autumn and may start raising rates six months later. That sparked a selloff in bonds.

But data showing U.S. manufacturing slowed in March, after nearing a four-year high last month, led to doubts the Fed would move that fast if economic growth falls short of forecasts.

"Markets are concerned about the weakness in the U.S. economy, whether it is weather-related or not," said Nick Stamenkovic, bond strategist at RIA Capital Markets.

German Bund yields last traded 4.5 basis points down on the day at 1.59 percent, reversing most of the rise seen after Yellen spoke. Yields on other top-rated euro zone bonds fell 3-4 bps. Spanish and Italian yields were flat, having fallen after the U.S. data.

Manufacturing data for Germany also came out weaker than expected, although similar data showed faster growth in France than had been forecast.

ECB, FED DIVERGENCE

Comments by European Central Bank Governing Council member Erkki Liikanen that the bank would keep interest rates low well into the euro zone recovery also pulled yields down. Liikanen cited high unemployment and the fact that many factories are running well below capacity. [ID:nL6N0MI2TN}

Euro zone money markets have mostly priced out expectations of an ECB interest rate cut in coming months. But the bank is still expected to keep monetary policy ultra-easy, with inflation remaining at ultra-low levels.

Liikanen also said on Monday that the ECB is keeping a close eye on the euro exchange rate to see how it affects inflation, and that it stands ready to act if the inflation rate appears headed in the wrong direction.

Euro zone inflation stood at 0.7 percent in February, far below the ECB's target of just below 2 percent. The ECB expects inflation to rise slowly over the next couple of years to 1.5 percent in 2016 and it sees only limited deflation risks.

"At the moment there's no real deterioration in the macroeconomic side, which is speaking to the ECB being on hold for now, but what you still have to look at is the inflation numbers which could still see something happen from the ECB," said Commerzbank strategist Benjamin Schroeder.

Greek yields continued to buck the upward trend, extending last week's falls after Standard & Poor's said on Friday it may raise the country's credit ratings if growth picks up more substantially. S&P kept the rating deep in junk territory with a stable outlook.

Greek 10-year yields fell 19 bps to 6.73 percent with 30-year paper yielding 6.59 percent, down 13 bps. Yield-hungry investors have been flocking back to Greek and Portuguese markets this year as the outlook for the bailed-out countries improved and alternatives looked more expensive or increasingly risky. (Editing by lARRY kING)

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