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UPDATE 1-Euro zone inflation expectations lift off record lows on stronger yuan
February 15, 2016 / 4:50 PM / 2 years ago

UPDATE 1-Euro zone inflation expectations lift off record lows on stronger yuan

(Updates prices for close)

By Marius Zaharia

LONDON, Feb 15 (Reuters) - Euro zone long-term inflation expectations rebounded from record lows on Monday after China’s central bank fixed the yuan rate stronger, easing some recent worries about a devaluation.

Bond yields in the euro zone’s most indebted states fell and stress indicators in bank-to-bank lending eased as market concerns subsided that Chinese currency weakness would spread growth-crippling deflation across the developed world.

Portuguese 10-year bond yields were around a percentage point down from last week’s highs hit when investors became worried about China’s economic slowdown and the health of the world’s banks.

Spot yuan jumped more than 1 percent to 6.4900 per dollar, its firmest this year, after the People’s Bank of China set its daily midpoint 0.3 percent stronger. The head of the bank was quoted saying speculators should not be allowed to dominate market sentiment.

The most widely followed measure of the market’s long-term inflation expectations for the euro zone -- the five-year, five-year, breakeven forward -- rose to 1.46 percent from a record low of 1.44 percent touched last week.

The measure, which shows where markets expect 2026 inflation forecasts to be in 2021, remains well below the European Central Bank’s target of just below 2 percent.

“We had a very strong statement from the Chinese authorities signalling they are committed to a stable currency and that’s helped sentiment,” said RIA Capital Markets bond strategist Nick Stamenkovic. “But there’s still a lingering suspicion among investors that they might still devalue the yuan going forward.”

German 10-year Bund yields were 2 basis points lower at 0.24 percent, lagging behind in a broad rally as investors shifted to riskier assets such as stocks and higher-yielding debt.

Stamenkovic said the underlying market mood remained fragile due to worries about banks, the uncertain outlook for China, and concerns about the United States after its first interest rate rise in almost a decade last December.

EASING PRESSURE

Ten-year Portuguese yields fell 14 basis points to 3.48 percent, 90 basis points below last week’s high.

Some saw last week’s sell-off in Portugal as a throwback to the 2011-2012 euro zone debt crisis, but other analysts said such parallels were misguided since the ECB is now buying bonds and could increase those purchases next month.

“The ECB will not want to see the euro periphery trading once more as a credit market, having seemingly won the battle to restore confidence in 2012,” said Mark Dowding, co-head of investment grade debt at BlueBay Asset Management.

ECB president Mario Draghi said on Monday that the bank was ready to ease monetary policy in March but dismissed the prospect, raised by the Italian Treasury, that it could buy asset-backed securities (ABS) based on bad loans as part of its quantitative easing programme.

Such a move could have helped a recently approved Italian scheme aimed at helping banks to offload some of their 200 billion euros ($225 billion) of bad debt and free resources for new loans.

Worries about banks have fuelled selling pressure on southern European debt in recent weeks. Stress indicators in bank-to-bank lending, derived from the difference between overnight rates on a forward curve and longer-term Libor rates, were recovering from their highest levels in more than a year.

The euro forward BOR/OIS contract starting in March and ending in June EURL-OIMM1=R narrowed to just under 14 basis points from a high of 17 bps last week. At the peak of the euro zone crisis, the spread was almost 150 bps, and in the wake of the Lehman Brothers collapse in 2008 it was almost 230 bps. (Reporting by Marius Zaharia, editing by Jeremy Gaunt and Katharine Houreld)

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