By Emelia Sithole-Matarise
LONDON Nov 1 Euro zone bonds broadly edged
higher on Friday, extending this week's rise after data showing
a surprisingly sharp slowdown in euro zone inflation increased
bets that the European Central Bank may ease monetary policy
The October inflation data, which came in way below the ECB
target of just under 2 percent, offset the impact of
forecast-beating U.S. data and a Federal Reserve statement on
Wednesday that was perceived to be less dovish than anticipated.
Short-term euro zone inflation gauges as measured by French
breakeven rates, the yield spread between euro zone
inflation-protected government bonds and equivalent nominal
debt, have plumbed to July lows since the report.
Many in the market expect the ECB at least to signal a rate
cut or new liquidity injections at its meeting next week, while
holding fire until December when it will have updated
medium-term inflation and growth forecasts.
"The inflation reading yesterday supports the maintenance of
low rates, steeper (bond yield) curves ... which will all put
pressure on the ECB," said Padhraic Garvey, head of investment
grade debt strategy at ING in Amsterdam.
Shorter-dated Spanish and Italian yields fell 4 basis points
to 1.11 and 1.40 percent respectively
while 10-year yields were down 2 basis points at 4.02
and 4.11 percent.
In core euro zone bonds, German two-year yields
, the most sensitive to shifts in monetary policy
expectations, were 2 basis points lower at 0.11 percent, their
lowest since Aug. 1, steepening the 2- to 10-year yield curve by
3 bps to 158 bps. Bund futures were 9 ticks lower at
141.91, having hit a two-month peak of 142.32 on Thursday.
"The market is now strongly expecting the ECB to deliver
something by the December meeting so the front end is extremely
well bid," a trader said.
"Longer-dated Bunds to some degree are going to trade with a
bit of a bias towards what Treasuries will do after the Fed was
not so dovish."
The market is expected to stay supported ahead of the ECB
meeting next Thursday, though the bank has not sent any official
signals of imminent easing since its October meeting.
It is also unclear whether the ECB would opt to cut rates or
prefer to give banks another dose of cheap long-term loans.
Societe Generale strategists said in a note they expected
the central bank to cut interest rates to a record low 0.25
percent from the current 0.50 percent in December.
"From the ECB perspective, a key rate cut would weigh
on the euro/dollar near term and help anchor inflation
expectations that otherwise could drop sharply," they said.
"However, it is doubtful that a rate cut alone would have a
lasting effect on the euro exchange rate and an LTRO (programme
of cheap loans) would probably have a bigger effect."