By Emelia Sithole-Matarise
LONDON, Nov 1 (Reuters) - 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 further.
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.”