* Bunds recover after shaky open
* Portugal lags peripheral rally
* Eonia dips below Monday's record low
* ECB's Weidmann warns against govt bond buying
(Updates prices, adds fresh comments)
By John Geddie
LONDON, June 13 German bonds recovered after an
earlier fall on Friday, as investors shrugged off worries that a
rate increase 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, dropped as much as 43 ticks at Friday's
open after Bank of England Governor Mark Carney said UK interest
rates might rise sooner than markets expect. But towards the
close of business in Europe, they had risen to 145.55, 30 ticks
up on the day.
Strategists said data confirming the euro zone's alarmingly
weak inflation served as a reminder that the paths of ECB and
Bank of England policy had completely diverged.
"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.
Worries over low inflation in the euro zone had centered on
the bloc's fragile peripheral states, but one of its strongest
credits was the 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 analyst forecasts for an uptick.
While the ECB has cut rates to 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 an 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 were 2 basis points down
on the day at 1.4 percent, having risen slightly earlier. 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 increased
demand for safe-haven German paper but did not seem to curb risk
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 4 bps to 2.67 and 2.79 percent respectively.
"(ECB chief Mario) Draghi has provided the opportunity for
spreads to move even lower, which is good news for peripheral
economies as borrowing costs for governments come down even
more," said Chris Iggo, chief investment officer for fixed
income at AXA Invstment Managers. "Ten-year bond spreads of
below 100 bps (over Bunds) for both Spain and Italy look
Italian and Spanish yield gaps over Bunds are now at 142 and
130 bps respectively.
In money markets, the overnight bank-to-bank Eonia lending
rate 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 keeping short-term rates low.
Liquidity will get 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 room for money rates to fall in months ahead.
Hopes for a full-blown programme of government bond
purchases by 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.
(Additional reporting by Emelia Sithole-Matarise; Editing by