September 7, 2017 / 10:11 AM / in 10 months

UPDATE 1-Euro zone bond markets hunker down for the ECB

* U.S. fiscal plan pushes yields up

* ECB to start laying groundwork for QE exit

* Firm euro in focus

* ECB rate decision at 1145 GMT, news conference at 1230 GMT

* Euro zone periphery govt bond yields (updates prices)

By Dhara Ranasinghe

LONDON, Sept 7 (Reuters) - Euro zone government bond yields were higher on Thursday, with investors bracing for the European Central Bank to start laying the groundwork for an exit from its 2.3 trillion euro bond-buying stimulus.

A fiscal agreement between U.S. President Donald Trump and congressional leaders that includes a three-month suspension of the debt ceiling on Wednesday took the shine off safe-haven bonds, pushing up yields in the U.S. and Europe.

But the spotlight turned to the ECB meeting a day after a surprise rate rise in Canada served as a reminder that an era of extraordinary monetary stimulus globally is nearing an end.

The ECB is expected to start scaling back its asset-purchase scheme early next year given stronger economic conditions.

But with inflation subdued and the euro strong, the ECB is seen shifting its policy message only incrementally — possibly starting on Thursday.

“Bond markets want to get a sense of when the ECB will make an announcement on exiting QE (quantitative easing) and most now expect that in October,” said Marchel Alexandrovich, senior European economist at Jefferies.

“It will be interesting to see what they do with their growth and inflation forecasts today.”

ECB chief Mario Draghi is seen certain to ask the ECB’s committees to prepare policy options for the coming meetings, a signal that has in the past preceded actions.

The ECB could also tweak the bank’s long-standing guidance on asset buys, giving up a reference to the option of raising asset purchases, analysts say.

Draghi may also be questioned about the parameters of the bond-buying scheme since the central bank is pushing up against self-imposed limits in many countries including Germany where the bulk of purchases are made.


What the ECB says about the euro strength, however, could be the key driver for markets.

A sharp rally in the euro, which holds down the cost of imported goods and puts downward pressure on inflation, has cemented a view of a prolonged exit from monetary stimulus.

On a trade-weighted basis, the euro has gained nearly 6 percent in less than five months.

That strength has helped bond markets recover from heavy selling in the wake of Draghi’s comments in Portugal in late June - viewed by markets as sign that tapering is on its way.

Two-year German bonds yields, up marginally on Thursday at minus 0.76 percent, are near more than four-month lows hit this week.

Germany’s 10-year bond yield, up 2 bps at 0.36 percent , is down 23 bps from 18-month highs hit in July.

The combination of euro strength and dovish comments from ECB policymakers has also sparked a pull back in rate-hike expectations.

Forward Eonia bank-to-bank rates, a closely followed gauge of the market’s rate expectations, dated for the ECB meetings imply roughly a 50 percent chance of rate rise from the ECB by the end of 2018.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=

Reporting by Dhara Ranasinghe; Editing by Toby Chopra

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