German bonds firm up as investors prepare for ECB to act

Wed Jun 4, 2014 6:58am EDT

* Sell-off subsides as policy easing looms

* Media reports reiterate ECB dovishness

* Germany avoids third straight auction failure

* Investors still see juice in peripheral rally (Adds fresh quotes, updates prices)

By John Geddie

LONDON, June 4 (Reuters) - German bond yields firmed up on Wednesday and the country avoided a third successive uncovered auction ahead of what is expected to be a strong set of policy easing measures from the European Central Bank.

A bout of investor nervousness that pushed euro zone borrowing costs higher on Tuesday appeared to subside as markets waited for a package of steps from the ECB aimed at fighting low inflation and propping up the bloc's economic recovery.

"It is widely expected that the ECB will make modest moves in rates, such as lower the refi and deposit rate together, and will hold out the prospect of more easing in the months to come," said Ciaran O'Hagan, strategist at Societe Generale.

"The prospect of 'more to come' will keep the bullish, dovish dynamic alive."

Media reports overnight appeared to underline the ECB's readiness to act at Thursday's meeting as well as signaling future policy action. Bloomberg cited unnamed central bank officials as saying ECB President Mario Draghi is likely to say that any rate cut this week won't necessarily be the last even though the deposit rate is expected to move into negative territory for the first time.

One official added that an anticipated scheme designed to boost lending to small and mid-sized firms could see the ECB offering banks funding equivalent to 5 percent of their outstanding loan portfolios.

Commerzbank estimates that such a scheme, based on all outstanding euro area bank loans, could amount to as much as 530 billion euros, while if it is just limited to non-financial peripheral corporations it would be around 90 billion euros.

Some, such as BNP Paribas strategist Patrick Jacq, say the ECB may even signal it will launch an asset purchase scheme, as other major central banks have done.

However, others pointed to Tuesday's sell-off as evidence that the ECB could still disappoint.

"With every man and his dog expecting rate cuts and conditional liquidity measures, positioning has become overly lopsided and market participants started to see the risk of disappointment in the details of the ECB's easing package," said Commerzbank in a research note.

Ten-year German bond yields, the benchmark for euro zone lending, opened one basis point lower at 1.35 percent, reversing some of Tuesday's losses which saw yields rise as much as seven basis points.

The firmer backdrop helped support demand at a sale of five-year German bonds on Wednesday, as it managed to avoid a third successive uncovered auction.

'SOME JUICE LEFT'

In the periphery, yields on Spanish and Italian bond inched 1bp higher to 2.87 and 3.00 percent, respectively, but still remain just above record lows.

Investors say signs of rebounding economic growth and accommodative central bank policy means there is still value in the bloc's most vulnerable debt securities.

Spain's service sector expanded for the seventh month running in May, while Italy's expanded for the second straight month, data showed on Wednesday.

"We think there is still some juice left," said Philip Poole, head of global research at Deutsche Asset Management.

"With the ECB introducing negative deposit rates, there is a desire on the part of investors for yield and the periphery is still offering decent upside."

While many argue the differing economic cycles on either side of the Atlantic have seen a decoupling in U.S. and euro zone rates products, investors will still be keeping a close eye on U.S. ADP employment data due out later on Wednesday.

That data, a precursor to Friday's nonfarm payroll release, comes amid calls from some U.S. Federal Reserve officials to start raising rates steeply once it has finished winding down its programme of asset buying. (Editing by Hugh Lawson)

FILED UNDER:
Comments (0)
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.