July 31, 2018 / 7:49 AM / 10 months ago

UPDATE 1-French, German yields drop as Japan clings to monetary stimulus

* Bank of Japan keeps yield target, says rates to stay low

* French bond yields lead fall, dropping 4 bps

* Euro zone bond yields down 2 to 4 bps across the board

* Euro zone inflation data due later on Tuesday

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Adds background, quotes)

By Abhinav Ramnarayan

LONDON, July 31 (Reuters) - French and German government bond yields dropped on Tuesday after the Bank of Japan said it would keep interest rates low, meaning Japanese investors are likely to continue investing in the euro zone bond market.

The BoJ took measures to make its stimulus programme more flexible but pledged to keep interest rates low for now on Tuesday, reflecting its forecast that it would take time for inflation to hit its 2 percent target.

That pushed Japanese 10-year government bond yields down to 0.06 percent, off Monday’s 18-month high of 0.11 percent .

The yield on French 10-year government bonds — a market favoured by Japanese investors — dropped 4 basis points to 0.71 percent in early trade. The German equivalent fell 3 bps to 0.415 percent.

“Given all the speculation over larger scale changes, we’re seeing some short covering today in euro zone bond markets. What also helps is the weaker data that we’ve seen recently,” said Commerzbank strategist Christoph Rieger.

French and German government bonds had sold off in recent days on the possibility that the BOJ abandon its yield range target.

Instead, the bank only made it more flexible, changing the targeted range on 10-year Japanese government bond yields from plus or minus 10 basis points to 20 basis points.

According to Commerzbank estimates, Japanese investors held over 170 billion euros of French government bonds at the end of 2017, about 10 percent of the 1.72 trillion euros outstanding at the end of May 2018, according to French debt agency data.

In addition, slightly lower German inflation data from Monday — with no significant change to core inflation — may also be putting downward pressure on yields.

The wider euro zone figure is due out later on Tuesday, which could affect markets if the figure, particularly after stripping out the effect of energy and food prices, is different from consensus.

Market expectations are for a year-on-year increase of 2 percent, with core inflation expected to come in at 1.2 percent, according to a Reuters poll.

The Bank of England meets later this week, with the market expecting it will raise rates as the British economy recovers from an early 2018 slowdown caused by an unusually cold winter . (Reporting by Abhinav Ramnarayan, editing by Larry King)

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