Euro zone bond yields edge up as bets on ECB asset buys subside

Tue Apr 29, 2014 3:42am EDT

By Marius Zaharia
    LONDON, April 29 (Reuters) - Euro zone bond yields edged
higher on Tuesday as speculation the ECB will launch an asset
purchase programme any time soon subsided, though bets that it
may cut rates or inject liquidity picked up.
    European Central Bank President Mario Draghi told lawmakers
from Germany's ruling coalition on Monday that low inflation
would persist but quantitative easing (QE) remained some way
off, according to a source who took part in the meeting.
    Draghi's deputy Vitor Constancio also said that April
inflation figures alone should not trigger a policy change.
German inflation figures are due at 1200 GMT on Tuesday, while
euro zone numbers are due on Wednesday. 
    "Draghi downplaying QE is getting some attention," one
trader said, explaining the small rise in yields across the euro
zone. "But obviously this is a big data day and any soft
(inflation) numbers would change sentiment really quickly."
    German 10-year Bund yields, the benchmark for
euro zone borrowing costs, rose 1 basis point to 1.51 percent.
Spanish and Italian yields rose 2
bps to 3.09 percent and 3.16 percent, respectively.
    Low-rated euro zone bonds faced selling pressure from
investors making room in their books before a sale of up to 9
billion euros of Italian bonds.
    German inflation is expected to rise to 1.4 percent in April
from 1.0 percent in March, while euro zone inflation is seen at
0.8 percent, up from 0.5 percent in the previous month.
    
    TIGHT LIQUIDITY
    While expectations about the ECB printing money subsided,
bets that the central bank may cut interest rates or inject more
liquidity into the banking system increased.
    A drop in the level of spare cash in the banking system to
its lowest since 2011 at 86.6 billion euros pushed overnight
bank-to-bank Eonia borrowing costs to 0.398 percent.   
That was the highest Eonia rate since 2011 with the exception of
two liquidity-tight days at the end of last year and at the end
of the first quarter of 2014.
    Central banks would prefer overnight rates to trade within
the band formed by their key deposit and refinancing rates - now
at 0-0.25 percent.
    Draghi said earlier this year an "unwarranted" rise in money
market rates would be a trigger for further monetary policy
easing along with a worsening of the inflation outlook.
    "Money market developments are putting more pressure on the
ECB. If rates don't come down, the ECB is bound to do
something," said Jan von Gerich, chief fixed income strategist
at Nordea in Helsinki.
    Liquidity in money markets is shrinking as banks are
repaying early the three-year emergency loans they took from the
ECB at the height of the crisis in December 2011 and February
2012, a process that is expected to continue.
    But the amount of spare cash in the system depends on other
ECB liquidity operations as well. If banks increase their
take-up at Tuesday's weekly offering of unlimited one-week loans
the pressure on money market rates may subside.
    The ECB is also holding a tender for deposits aimed at
draining 177.5 billion euros, which is the amount equal to its
current holdings of government bonds purchased via its Security
Markets Programme at the height of the crisis.
    That sterilisation operation was introduced to quell
concerns that the SMP programme was a way of directly financing
governments, something which the ECB is not allowed to do. If it
fails to drain the full amount, as it happened on several
occasions in the past, that would be the equivalent of a cash
injection and liquidity tensions may ease.
    "A significant cash injection at today's ECB operations is
needed to calm things down," said Christoph Rieger, rate
strategist at Commerzbank.

 (Reporting by Marius Zaharia; Editing by John Stonestreet)
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