Lower-rated euro zone yields pinned at multi-year lows

Tue May 6, 2014 3:56am EDT

* Markets welcome Portuguese plans for "clean" bailout exit

* Portuguese bond yields at 8-year lows

* Some expect ECB to stop sterilising bond purchases

By Marius Zaharia

LONDON, May 6 (Reuters) - Yields on the euro zone's lower rated bonds hit multi-year lows on Tuesday as investors welcomed Portugal's plans for a "clean" exit from its bailout and continued to expect some future easing of ECB monetary policy.

Following in the footsteps of Ireland, Portugal said it would end its international bailout this month without a back-up loan. Barely two years ago, Lisbon had been seen as at risk of defaulting on its debts.

Rather than worrying about the lack of a future safety net, market participants saw Portugal's move as further confirmation of an easing of the wider euro zone debt crisis.

Portuguese 10-year yields were last 3 basis points lower on the day at 3.61 percent, having hit a new eight-year low of 3.597 percent earlier, according to Reuters data.

"It's a normal step," said KBC strategist Piet Lammens of Lisbon's move. "Sentiment in the market is very strong so it will not unsettle the market."

Other yields in the euro zone's weaker states were also 1-3 basis points lower. In Spain, 10-year yields matched their record lows at 2.97 percent, with Italian yields also matching their lows at 3.029 percent.

The trend of falling yields remains supported by expectations that the European Central Bank may ease monetary policy further as inflation remains below expectations and more than one percentage point below target.

ECB ACTION?

No rate cut is seen at the ECB's meeting on Thursday and any move to print money by buying assets is likely to be some way off. However, recent stress in money markets has rekindled some expectations of another liquidity injection.

This could come in the form of suspending the weekly ECB deposit tenders aimed at draining from the market an amount equal to the outstanding volume of government bonds purchased by the central bank via its Security Market Programme (SMP) at the height of the crisis.

The so-called "sterilisation" operations were introduced to quell any concerns that the SMP was directly financing state budgets, something the ECB is not allowed to do. Suspending them would release 167.5 billion euros in the market.

Speculation that the ECB might consider such a move picked up at the end of last month when a spike in overnight bank-to-bank Eonia lending rates above the 0.25 percent refinancing rate led to the ECB failing to drain the full intended amount.

The failure, coupled with an increased take-up from banks at the ECB's weekly offerings of unlimited loans, was the equivalent of a liquidity injection, which eased tensions in the money market and Eonia has fallen back to 0.126 percent.

But cheap overnight money may again lead to a small take-up of loans from banks and full sterilisation of the SMP programme at the ECB's regular liquidity operations later on Tuesday, eventually leading again to higher money market rates.

Many analysts say this type of volatility in money markets may create discomfort within the ECB, which wants interbank rates to remain low and stable to support the still-fragile economic recovery in the euro zone.

"The large unpredictable swing factor from the SMP operation should ... lead to second thoughts at the ECB about the usefulness of this operation," Commerzbank rate strategist Christoph Rieger said. (Editing by Gareth Jones)

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