Portugal's clean exit, bets on ECB put periphery yields at record lows

Tue May 6, 2014 7:34am EDT

* Markets welcome Portuguese plans for "clean" bailout exit

* Portuguese bond yields at 8-year lows

* Some expect ECB to stop sterilising bond purchases (Updates prices, adds comments)

By Marius Zaharia

LONDON, May 6 (Reuters) - Yields on the euro zone's lower-rated bonds hit record 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 confirmation the euro zone debt crisis was subsiding.

Portuguese 10-year yields were last 4 basis points lower on the day at 3.60 percent. They had hit an eight-year low of 3.59 percent earlier, according to Reuters data.

By comparison, they had soared to more than 17 percent at the height of the crisis in 2011-2012. Few predicted then that a country whose debt stands at 1.3 times its economic output and still struggles with high unemployment could regain investor confidence so swiftly.

"Despite these challenges ... we believe Portugal's bailout exit represents an important symbolic transition from the worst of the crisis," said Dennis Shen, economic associate at AllianceBernstein.

Other yields in the euro zone's weaker states were also 2-3 basis points lower. Ten-year yields in Spain, Italy and Ireland reached record lows at 2.95 percent, 3.015 percent and 2.755 percent, respectively.

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


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.

That could come from suspending weekly ECB deposit tenders. Those are aimed at draining from the market an amount equal to the outstanding volume of government bonds the central bank bought through 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 overnight bank-to-bank Eonia lending rates spiked above the 0.25 percent refinancing rate. Consequently, the ECB failed to drain the full intended amount.

Last month's 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. Eonia rates have fallen back to 0.126 percent.

But on Tuesday, cheap overnight money again led to a small take-up of ECB loans from banks and almost full sterilisation of the SMP programme at the ECB's regular liquidity operations.

This effectively pulls money out of the banking system and could bring back upward pressure on overnight interest rates, which may create discomfort within the ECB. It wants rates to remain low and stable to support the still-fragile economic recovery in the euro zone.

"(Money-market rates) are flipping around all the time. The only way to solve this is with counter measures," said Rabobank market economist Elwin de Groot, adding that such measures included rate cuts and a suspension of the SMP sterilisation. (Editing by Larry King)