* Bond yields steady near recent lows
* ECB widely expected to leave monetary policy unchanged
* Spike in Eonia rate spike keeps alive chances of ECB
By Marius Zaharia
LONDON, May 8 Euro zone government bond yields
held close to recent lows on Thursday as a spike in money market
rates kept alive an outside chance of the European Central Bank
easing monetary policy further at its meeting later in the day.
None of the economists polled by Reuters expected the
European Central Bank to make any move in May, a Reuters poll
showed last week.
However, dwindling spare cash in the banking system has
increased volatility in money markets in recent weeks. On
Wednesday, overnight bank-to-bank Eonia rates settled
at 0.26 percent, a touch above the ECB's main refinancing rate.
ECB President Mario Draghi has flagged "an unwarranted" rise
in money market rates as a potential trigger for monetary policy
easing, without pointing to any specific level of rates.
Analysts say the central bank would want overnight rates to
trade within the zero to 0.25 percent band defined by its
deposit and refinancing rates as otherwise its monetary policy
becomes less efficient.
The rates which banks pay to borrow cash in money markets
are being transferred onto businesses and consumers, thus a
significant and lasting rise in interbank rates would be the
equivalent of policy tightening.
This could slow down the euro zone's economic recovery and
cap inflation, already running well below the ECB's target at
just 0.7 percent.
"The wild card is what the ECB thinks of Eonia rates surging
yesterday," said Suvi Kosonen, an analyst at Nordea. "Volatility
is not the ECB's friend and the central bank has an option to
ease the liquidity situation already today."
German 10-year Bund yields, the benchmark for
euro zone borrowing costs, were flat at 1.475 percent, just off
11-month lows. Other euro zone bond yields were flat to slightly
higher, with Spanish, Irish and Italian yields keeping close to
the record lows they hit earlier this week.
The trend in lower yields has been supported this year by
expectations that the ECB will eventually move to tackle low
inflation. Half of the economists polled by Reuters expected
some form of policy easing by the end of the year.
Such expectations should ensure debt sales of up to 4.5
billion euros in Spain and 750 million euros in Ireland go
smoothly on Thursday.
Kosonen said rate cuts were unlikely, but the ECB could
suspend its weekly deposit tenders through which it drains money
from the banking system to neutralise the impact of the bond
purchases it made at the height of the euro zone debt crisis.
The tenders were introduced to quell concerns that bond
buying was direct financing of governments, something the ECB is
not allowed to do. A suspension, rather than a cancellation, may
not pose legal obstacles, analysts said.
Such a move would release 167.5 billion euros into the
banking system, a sum equal to the outstanding amount of bonds
the ECB bought under its defunct Securities Markets Programme.
Other analysts said the volatility in Eonia rates would only
be a concern for the ECB if it filtered through to short-term
bond yields, which was unlikely given that markets continue to
see a chance of further easing.
German two-year yields were last trading at
0.15 percent, well within this year's 0.07-0.27 percent range.
"The ECB will continue to show its willingness to fight
inflation and that will keep short-term yields low. The
volatility (in Eonia) should not be a concern for the ECB right
now," said ING rate strategist Alessandro Giansanti.
(Reporting by Marius Zaharia; Editing by John Stonestreet)