(Recasts to include market reaction to U.S. data )
By Dhara Ranasinghe and Abhinav Ramnarayan
LONDON, Sept 6 (Reuters) - Bond yields across the euro area fell sharply on Tuesday, pushed down by expectations that the ECB might deliver more stimulus when it meets this week and following weaker-than-expected U.S. data.
Spanish government bond yields slid almost 7 basis points and were set for their biggest one-day fall in almost six weeks as, along with the prospects of ECB easing, its economy showed signs of resilience to a domestic political stalemate that looks unlikely to be broken before December at the earliest.
Across the region, bond yields were 5-7 bps lower as investors speculated that the European Central Bank may extend its 1.7 trillion euro asset purchase programme and increase the pool of eligible bonds at Thursday’s policy meeting.
The fall in yields gathered pace on news that the U.S. economy’s service sector expanded more slowly in August than in July, with the fall the largest since the 2008 financial crisis.
The data, which followed Friday’s weak jobs numbers, supported a view that U.S. rates are likely to rise later rather than sooner, pushing Treasury yields down.
“The rally in euro zone bond markets today has been persistent and across the region, suggesting that there is speculation about what the ECB will do this week,” said BNP Paribas European rate strategist Patrick Jacq. “The weaker-than-expected ISM number has only added to the rally.”
Germany’s benchmark 10-year Bund yield fell to a three-week low at minus 0.109 percent, while 30-year yields tumbled more than 6 bps to 0.45 percent.
A gauge of long-term euro zone inflation expectations fell to its lowest level since July. The five-year, five-year breakeven forward fell below 1.26 percent -- towards record lows and further from the ECB’s near 2 percent inflation target.
“There is a bit of bullishness in the market ahead of the ECB meeting,” said Orlando Green, European fixed income strategist at Credit Agricole. “We are looking for an extension of the bond-buying programme.”
Having lagged their peers last week amid political concerns, Spanish bonds were back in favour, with the 10-year yield falling as low as 0.93 percent, down from last week’s one-month high above 1 percent.
Acting prime minister Mariano Rajoy’s chances of forming a coalition government were dealt a blow on Friday after he failed to win parliament’s backing for a second time, increasing the likelihood of another election.
Ratings agency Moody’s said on Monday that prolonged political deadlock would hurt Spain’s credit rating .
“The political situation is unsatisfactory, but maybe we have gotten reconciled to the fact that there will be some sort of compromise eventually,” said Norbert Wuthe, senior analyst, government bond strategy at BayernLB.
“The PMI figures may also explain the outperformance over Italy,” he said. Spain 10-year bonds yield trades 15 bps below its Italian equivalent, compared with 12 bps last week.
Activity in Spain’s services expanded at a faster pace in August, a survey showed on Monday, as business remained brisk in the hotel and restaurants industry during a record summer for tourism.
For Reuters new Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets (editing by John Stonestreet)