* Short-dated yields rise to multi-month highs
* Size of bank repayment to ECB is bigger than forecast
* Markets bet on more aggressive liquidity withdrawal
* Two-year U.S. yields rise above U.S. counterparts
By Marius Zaharia and Ana Nicolaci da Costa
LONDON, Jan 25 Two-year German bond yields hit
their highest since March 2012 On Friday, rising above their
U.S. counterparts, after the ECB said banks would pay back a
greater-than-expected 137 billion euros in loans next week.
The repayment was higher than the 100 billion euros ($134
billion) forecast in a Reuters poll - a sign that at least parts
of the financial system are returning to health.
Short-dated debt led a rise in yields across maturities,
with German bond prices having already come under selling
pressure after stronger-than-expected data boosted optimism
about the outlook for the euro zone's largest economy.
"It (the repayment amount) helped the Schatz yield higher,
but it is more of a symptom rather than the cause. The euro zone
situation has improved quite nicely," said David Keeble, global
head of fixed income strategy at Credit Agricole.
Two-year German yields rose 8.4 basis points to
0.261 percent. Keeble said they could rise further, but probably
not by more than 5 bps in the next three months as markets still
do not expect the ECB to raise rates any time soon.
On Friday, they overtook the premium offered by two-year
U.S. bonds for the first time in two years.
Some analysts said the higher-than-expected number was
prompting markets to price in a more aggressive repayment of the
European Central Bank funds, sapping the abundant liquidity that
helped calm the euro debt crisis in late 2011 and early 2012.
"Clearly this is putting some pressure on the front end of
the euro zone curve, given that the market is extrapolating this
larger repayment and taking the view that excess liquidity is
going to fall more quickly than initially expected," Michael
Leister, senior interest rate strategist at Commerzbank, said.
Five-year German yields rose 10 basis points to
0.66 percent - its highest since October 2012 - and 10-year
yields were 6 bps higher at 1.575 percent.
Yields were already higher before the announcement, as data
confirmed a rebound in the euro zone's largest economy.
Munich-based think tank Ifo said German business morale
improved for a third consecutive month in January to its highest
in more than half a year.
One day after upbeat private sector activity data, the Ifo
numbers prompted investors to dump safe-haven assets even as
data showed Britain's economy contracted more than expected in
the fourth quarter.
Bund futures fell 75 ticks on the day at 142.45.
KEEP CALM AND CARRY TRADE
Spanish borrowing costs over 10 years were
down 8.4 bps at 4.94 percent and the Italian equivalent
shed 3.4 bps lower to 4.12 percent.
"I doubt there were many peripheral banks taking part in
that pay-back," said Christian Lenk, strategist at DZ Bank.
"For the periphery, most of them should have taken the money
from the ECB to buy Italian and Spanish debt for carry and I
doubt they have an incentive to pay back the LTROs (long-term
refinancing operations) right now."
"Carry" refers to investors borrowing at the ECB cheaply to
put money in higher yielding bonds and make a profit.
While domestic banks are willing to keep hold of debt issued
by their governments, some foreign investors are wary of adding
Italian and Spanish bonds to their holdings after a steep fall
in yields since the ECB's bond-buying pledge in September.
Sanjay Joshi, head of fixed income at London and Capital,
said he was starting to sell some of the peripheral debt he had
bought in the past two to three months.
"The (ECB money) being returned is a sign of confidence in
the financial health of the periphery," said Joshi, whose firm
manages fixed income assets worth $1.5 billion.
"But deep in the background, unemployment is still rising,
non-performing loans are rising, as well and housing prices are
Italy's February elections could also shake investor
confidence, he noted.