October 25, 2018 / 10:55 AM / 21 days ago

UPDATE 2-Draghi's balancing act keeps euro zone yields hovering near lows

* Draghi confident in inflation but flags “bunch of uncertainties”

* Says also confident of agreement between Italy and EU

* Euro zone yields creep higher, but rises are limited

* Italian bond yields come off day’s lows (Rewrites throughout after ECB meeting)

By Abhinav Ramnarayan and Virginia Furness

LONDON, Oct 25 (Reuters) - Euro zone bond yields crept higher on Thursday but remained near recent lows after European Central Bank chief Mario Draghi expressed confidence in underlying euro zone inflation while flagging risks to the bloc’s economy.

Acknowledging a weaker recent momentum in the euro zone economy, Draghi reeled off what he called a “bunch of uncertainties” related to trade protectionism, emerging markets and financial market volatility.

A brief spike in borrowing costs while Draghi was speaking quickly reversed, and by the end of the conference they were flat to marginally higher on the day and within touching distance of recent lows.

“Draghi did a pretty good job of communicating the ECB is still on track to remove stimulus but is at the same time monitoring the risks without panicking or downplaying the situation,” said DZ Bank analyst Pascal Segesser.

“He also said if markets and price stability is hurt there would be measures they could take, tools they could use.”

Germany’s 10-year government bond yield, the benchmark for the bloc, was 1 basis point higher at 0.40 percent, only a shade higher than where they were before Draghi started speaking.

It is not far from a 1 1/2-month low of 0.378 percent hit earlier in the session.

The euro reversed earlier gains and fell on Thursday after Draghi said the monetary union remained fragile and failed to assuage concerns about financial instability in Italy.

Rate hike expectations remained steady, with money market investors pricing in around a 60 percent chance of a rate hike in September 2019.

Draghi also said he is still confident Italy will conclude an agreement with the European Union on its spending plans, after the Commission took the unprecedented step of asking Italy to resubmit its draft budget.

Asked about these comments soon after, Italian Deputy Prime Minister Matteo Salvini said, “I also want a deal, but on our terms.”

Italy’s 10-year government bond yields, which had dropped earlier in the day on improved risk sentiment in global markets and an upturn in Italian banking stocks, rose three bps through the conference to 3.50 percent.

It was still down 11 bps on the day and the spread over Germany was below recent highs at 311 bps.

“Draghi acknowledged a weaker momentum and talked about country specific factors, but mentioned that while there are also trade uncertainties, growth is turning to potential,” said Rabobank rates strategist Lyn Graham-Taylor.

Going into the ECB meeting, this week’s euro zone business surveys showed private-sector growth in the euro zone losing more momentum than expected, pointing to the slowest quarterly growth in more than two years.

The five-year five-year forward, a gauge of long-term inflation expectations in the euro zone, was at its lowest point since May 29 on Wednesday, standing at 1.667 percent and inching away from the ECB’s target of close to but below 2 percent .

Reporting by Virginia Furness; editing by Sujata Rao, Larry King

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