Peripheral yields fall as German data increase concern over growth

Tue Aug 12, 2014 11:26am EDT

* German investor morale at lowest since Dec. 2012
    * German 10-year yields not far from record lows
    * Italian, Spanish yields fall on ECB easing expectations

 (Updates prices, adds fresh quote)
    By Emelia Sithole-Matarise
    LONDON, Aug 12 (Reuters) - Yields on lower-rated euro zone
bonds fell on Tuesday after a survey showed German investor
morale had slumped, heightening concern about the region's
economic recovery and bolstering expectations the European
Central Bank will ease policy again.
    The ZEW index showed German analyst and investor morale fell
to its lowest in more than 1 1/2 years in August, as Europe's
largest economy was hit by fallout from the Ukraine crisis.
 
    The survey was the latest evidence of the effect on the
region of economic sanctions between Russia and the West, which
analysts say will hurt an already feeble and uneven euro zone
recovery.
    The ECB held fire at its policy meeting last week, but Mario
Draghi, the bank's president, cited the tension between Russia
and the West as a threat to growth in the currency bloc, leaving
the door open for further supportive action.
    "As far as markets are concerned, there's been a relapse in
economic performance in the euro zone," said Orlando Green, an
interest rate strategist at Credit Agricole.
    "Given that the ECB still has potentially more ... in its
toolbox, the market is also seeing that as a sign to keep the
bond market elevated, because the ECB could do more in terms of
loosening monetary policy."
    Italian and Spanish 10-year bond yields were 5-6 basis
points down at 2.74 percent and 2.49 percent
 respectively. Peripheral euro zone bonds have been
the main beneficiaries of the ECB's policy easing which has
driven their yields to historic lows.
    Both Rome and Madrid badly need growth and inflation to curb
already high levels of debt, and some analysts say investors are
taking a big risk relying on the ECB to save the day.
    "It looks like everybody is flying on a plane which at some
point slows down and then everybody is cheering because the
plane is losing altitude," said Gianluca Ziglio, executive
director of fixed income research at Sunrise Brokers. 
    
    "TIMID" ECB
    A flight to quality that had pushed Bund yields to all-time
lows last week began losing some of its steam after Russia
stopped military drills on its eastern border with Ukraine. But
tension began to build again with a Russian plan to send an aid
convoy into eastern Ukraine. That supported
underlying demand for assets seen as safe havens. 
    German Bund yields, the benchmark for euro
zone borrowing costs, were a touch lower at 1.06 percent, not
far from a record low of 1.024 percent reached last week. 
    Some in the market expect Bund yields to fall further to a
low of 1 percent if the slowdown in euro zone growth is
confirmed and if the ECB continues its wait-and-see stance on
further policy easing.
    "Bunds are not expensive at 1 percent if growth momentum is
slowing, whilst the ECB continues to make a policy error of
timidity (on further cuts to its main interest rate).... Both
conditions need to be reversed for us to sell Bunds and neither
seems likely in 2014," RBS strategists said in a note.

 (Additional reporting by Marius Zaharia; Editing by Larry King)
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