July 26, 2019 / 7:29 AM / 2 months ago

Everything but the cut: European bond yields lower on easing expectations

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Virginia Furness

LONDON, July 26 (Reuters) - Euro zone government bond yields began to reverse some of the rises seen after Thursday’s European Central Bank meeting, where policymakers left rates unchanged but opened the door to more easing, underwhelming investors who had hoped for more.

Expecting ECB President Mario Draghi to prepare the ground for another round of monetary easing, if not a rate cut, investors had piled into euro zone government bonds before the meeting, but some of the positioning was unwound during Draghi’s comments to the press.

Draghi told reporters “this (economic) outlook is getting worse and worse”, increasing the need for stimulus. But investors latched on to his comment that the ECB wanted to see more projections of how the economy was performing before taking action.

Commentators were quick to point out that Draghi has delivered everything but the cut — signalling both tiering and the resumption of asset purchases — and euro zone bond yields began to retreat from the rises seen in both the core and the periphery.

Germany 10-year bond yields were two basis points lower at -0.376%, heading back down towards the record low of -0.422%, recorded on Thursday.

Other 10-year yields in the bloc were also around two basis points lower,,.

“The ECB’s dovishness has been massively under-estimated,” Mizuho analysts wrotein a note on Friday.

With tiering now likely, they said, the ECB has no effective lower bound to its policy rates, meaning that “real rates can now be pushed to extremely negative levels.” However, the bank does not believe that the next easing steps will be successful.

Focus now turns to September. A rate cut at the ECB’s September meeting appears certain, four sources close to the discussion told Reuters on Thursday. Government bond purchases and a revamped policy message were also likely, they said.

Money markets are now pricing in an 88% chance of a 10-basis-point hike at the ECB’s September meeting.

Investors also appear unperturbed by political ructions in Spain, where parliament rejected Pedro Sanchez’s bid to be confirmed as prime minister on Thursday. That put the country on a path to what would be its fourth national election in as many years - unless he succeeds in another attempt.

Spanish 10-year bond yields have fallen some 120 basis points since the start of the year and were last seen at 0.342% .

In a further sign of global economic weakness, data is expected to show the U.S. economy grew at its slowest pace in more than two years in the second quarter, as an acceleration in consumer spending was probably offset by weak exports and business investment.

Reporting by Virginia Furness, editing by Larry King

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