* Bunds recover after shaky open
* Portugal lags peripheral rally
* Eonia dips below Monday's record low
* ECB's Weidmann warns against govt bond buying
(Adds fresh comments, updates prices)
By John Geddie
LONDON, June 13 German bonds recovered after an
earlier fall on Friday, as investors shrugged off worries that a
rates rise in the UK would have a knock on effect for euro zone
government borrowing costs.
Bund futures, the most actively traded securities in
euro zone bond markets, initially dropped as much as 43 ticks at
Friday's open after Bank of England Governor Mark Carney said UK
interest rates could rise sooner than financial markets expect.
However, by mid-morning, Bund futures made a full reversal,
climbing to daily highs of 145.63, 37 ticks up on the day.
Strategists said data confirming the euro zone's alarmingly
weak inflation served as a reminder that the path of ECB policy
had completely diverged from its peer across the channel.
"These deflation pressures show the ECB will keep rates low
for a very long time, which is the most important thing for
investors," said Christian Lenk, strategist at DZ Bank.
Fears around low inflation in the euro zone have centered on
the bloc's fragile peripheral states, but it was one of its
strongest credits that was a cause for concern on Friday.
Finland's consumer prices rose just 0.8 percent in May, down
from 1.1 percent the previous month. Germany's final inflation
reading for May was also left unchanged at just 0.6 percent,
despite some analysts predicting an uptick.
While the ECB has cut rates in negative territory in an
attempt to stave off deflation and stimulate bank lending, the
BoE is gearing up to raise rates to cool its buoyant housing
market and support economic recovery.
"The euro area should be a bit immune to UK rates, given the
stance of the European Central Bank." said Piet Lammens,
strategist at KBC.
German 10-year yields initially opened 1 basis
point higher at 1.4 percent, but then reversed to trade lower on
the day. The yield spread over equivalent 10-year gilts was also
pushed to its widest level since mid-1997.
Bond traders said an escalating civil war in Iraq bolstered
investor appetite for safe haven German paper, but it did not
appear to dampen risk appetite elsewhere.
Markets appeared to easily digest over 18 billion euros of
low-rated bonds sold by Spain, Italy and Portugal on Thursday.
Spanish and Italian 10-year bond
yields dropped 1bps lower on Friday, to hit 2.69 and 2.81,
respectively, while Greece's dropped 3 bps to 5.73 percent.
Portugal bucked the trend, with 10-year yields rising 1 bps
to 3.39 percent, after its finance minister said on Thursday
that the country would do without the last payment from its
international bailout program after the country's constitutional
court rejected a series of austerity measures.
In money markets, the overnight bank-to-bank Eonia lending
rate EONIA= fixed at 0.043 percent, beating record lows set on
Monday before the European Central Bank's negative rate on
The amount of cash euro zone banks have beyond what they
need for their day-to-day operations is a key
factor holding short-term rates low.
Liquidity will be given a boost next week when the ECB stops
withdrawing cash from the banking system to neutralise the
effect of the bond purchases it made under the now defunct
Securities Markets Programme (SMP).
It has also introduced 400 billion euros of ultra-cheap
four-year loans for banks - conditional on their lending to the
smaller companies that are Europe's economic backbone - which
will be available from September.
With forward Eonia rates dated for November and December
showing an implied rate of around 0.03, there is
clearly scope for money rates to fall in months ahead.
Hopes for a full-blown programme of government bond
purchases from the ECB are more remote, however. Bundesbank
chief Jens Weidmann called them "sweet poison for governments"
that undermine the central bank's ability to do its job.
(Editing by Alexandra Hudson and Toby Chopra)