UPDATE 1-Spanish yields hit record lows on ECB's easing signals

Wed May 28, 2014 12:24pm EDT

* ECB policymakers prepare ground for easing next week

* Weak lending, German jobless data adds pressure

* Peripheral and core euro zone bonds drop

* Low returns thwart Germany's 30-yr auction (Adds fresh quote, Reuters poll results)

By Emelia Sithole-Matarise and John Geddie

LONDON, May 28 (Reuters) - Spanish bond yields fell to record lows on Wednesday as weak lending data and comments by European Central Bank policymakers bolstered expectations the bank will soon provide monetary stimulus, fueling demand for fixed income.

Euro zone government bonds across the credit spectrum have gained this week as fears receded that big wins by anti-euro parties in EU parliamentary elections might derail fiscal reforms in weaker countries. At the same time, expectations grew that the ECB will ease policy next week.

ECB executive board member Yves Mersch ramped up the rhetoric on Wednesday, saying the June 5 meeting could yield a combination of policies to tackle low inflation and low credit growth, but the timing of implementation could vary. That followed similar hints by ECB President Mario Draghi and colleague Ewald Nowotny earlier this week.

"All these ECB officials appear to be singing from the same hymn sheet and are preparing the ground for action next week," said Nick Stamenkovic, a bond strategist at RIA capital markets.

Data showing falls in lending to households and firms in the euro zone, a slump in money supply growth, and a surprising uptick in German unemployment, further supported the case for ECB action.

Measures being prepared by the ECB are likely to include cutting the deposit rate into negative territory - effectively charging banks to hold cash at the ECB overnight - and bank loans aimed at helping to increase lending to smaller companies.

Thirty-one of 48 economists polled by Reuters this week said such a combination would help boost lending in the euro zone.

Spanish 10-year yields fell 8 basis points to a record low of 2.80 percent, according to Reuters data. Italian equivalents were 7 bps lower at 2.91 percent, not far from the record low of 2.89 percent they reached two weeks ago.

Italian yields extended this week's declines after Prime Minister Matteo Renzi's party scored a surprisingly big win in EU parliamentary elections over the anti-establishment 5-Star Movement.

LOW YIELDS

German 10-year yields, the benchmark for euro zone borrowing, also dropped 5 bps to hit lows for the year of 1.29 percent, according to Tradeweb data, despite a disappointing auction of 30-year bonds on Wednesday.

Ultra-low yields were blamed for poor investor demand at Germany's auction, where the Bundesbank had to retain bonds to allow the country its 2 billion euro target. It was the second successive German auction to be technically uncovered, following a 10-year sale last week, and the fifth this year.

"Given the very expensive levels reached by the Bund, what's the point of going for the 30-year Bund when you can go for some yield pick-up in (French) OATs or Spanish 30-year?" said Jean-Francois Robin, a strategist at Natixis.

The 30-year Bund yielded 2.24 percent in the secondary market, just over 50 bps more than similar-maturity French bonds and 175 bps above Spanish 30-year yields.

The firmer market tone is, however, expected to augur well for an Italian auction on Thursday of 6.0 billion to 7.5 billion euros of five- and 10-year bonds, after a smooth sale on Tuesday of 3 billion euros of zero-coupon debt and 1 billion euros of inflation-linked bonds.

"There might just be a little bit of concession going into the auction tomorrow but it should go OK," a trader said.

"Bigger picture, we still remain constructive on the periphery given the ECB outlook and think there will be further compression in spreads." (Editing by Larry King)

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