Portuguese bond yields rise after top court rejects budget cuts

Mon Jun 2, 2014 3:47am EDT

* ECB policy easing expectations soothe market nerves

* German inflation reading in focus

By John Geddie

LONDON, June 2 (Reuters) - Portugal's bond yields rose on Monday after its supreme court rejected several austerity measures in the government's 2014 budget.

Ten-year yields opened 7 basis higher at 3.72 percent, before paring some of those losses with the broader debt market underpinned by expectations the European Central Bank will announce a stimulus package on Thursday.

"It's a disturbance to the market, a reminder that it is not so easy to get these countries back on track," said Luca Jellinek, European head of fixed income at Credit Agricole.

Portugal, which needs to sharply cut its budget deficit in coming years under European Union agreement, has been forced to review its finances a number of times in the past years following interventions from its top court.

The latest ruling announced after markets closed on Friday creates an estimated fiscal gap of 700 million euros.

Traders said, however, that weakness in Portugal's debt should be short-lived with the ECB poised to announce a number of policy measures at its June meeting on Thursday designed to protect the euro zone's fragile recovery.

"Investors will use any weakness as an opportunity to buy," said one euro zone government bond trader.

The package of measures is expected to include an unprecedented cut in the ECB's deposit rate into negative territory and measures aimed at boosting lending to small and mid-sized firms (SMEs).

Anticipation of these measures has kept borrowing costs in some of the euro zone's most fragile states down. Yields on Italian and Spanish 10-year bonds dipped 1 bps to 2.96 and 2.85 percent respectively on Monday, just above record lows.

With ECB policymakers closely focused on stubbornly low inflation in the euro zone, the preliminary reading of German CPI later on Monday will be of added importance ahead of euro wide data later this week.

Italian Economy Minister Pier Carlo Padoan said on Saturday that deflation would be a disaster for the euro zone and for countries with high public debt in particular.

Euro zone inflation stood at just 0.7 percent in April, far below the European Central Bank's (ECB) target of just below 2 percent, and is expected to remain at the same level in May according to a Reuters survey of analysts. (Reporting by John Geddie; Editing by John Stonestreet)

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