UPDATE 3-Southern European bonds, euro zone stocks pummelled as ECB disappoints

(Adds context and inflation expectations, updates prices)

LONDON, March 12 (Reuters) - Southern European bond yields soared on Thursday, euro area stocks were set for their worst day ever and the euro tumbled as markets expressed disappointment in the European Central Bank’s easing measures to contain the fallout from the coronavirus.

A comment by ECB chief Christine Lagarde that the central bank was not there to “close spreads” hit peripheral government bond markets especially hard.

Italy’s 10-year bond yield soared almost 60 basis points on the day to its highest level since July at around 1.88% - and was on track for its biggest one-day jump since the height of the euro zone debt crisis in 2011. The yield was slightly lower at 1.75% in late European trade.

The closely watched gap between Italian and German 10-year bond yields, effectively the risk premium the latter pays on its debt - pushed out to its widest since June at around 261 bps.

The Portuguese/German bond yield gap rose to 145 bps - its widest in over a year, while Portuguese and Spanish yields were set for their biggest daily jump since 2016 with rises of 17-30 bps.

“The key bit was: ‘we’re not here to close spreads’, that’s kind of the opposite from ‘whatever it takes’ of Draghi,” said Rabobank rates strategist Lyn Graham-Taylor, referring to former ECB chief Mario Draghi.

“For us, [if they call for] a fiscal response in the face of a severe economic crisis, without any debt mutualization, just sell peripherals all day long.”

In a volatile session, safe-haven German bond yields swung wildly before heading back down in the face of heavy selling in stock markets and peripheral bonds.

Germany’s two-year bond yield was marginally higher at -0.94%.

Earlier, the ECB said it would offer fresh loans to banks, provide previously agreed liquidity facilities at even more favourable rates and it would temporarily increase asset purchases to help the economy cope. But it disappointed markets by keeping interest rates unchanged.

“She delivered what was the consensus. Markets ... clearly they wanted a lot more,” Barnaby Martin, head of credit strategy at BofA, said.

A key gauge of euro zone inflation expectations hit a new record low at around 0.86%, far below the ECB’s target of close to but below 2%.

The euro weakened nearly 1.8% to $1.10710 by 16:24 GMT, having briefly risen immediately after the ECB’s announcement.

Euro zone equities were set for their biggest one-day fall ever, sliding 11%, and at their lowest levels since June 2012. Euro zone banks also tumbled over 10%.

“There’s a capitulation of some sorts given the total uncertainty of what’s ahead of us,” said Mikael Jacoby head of continental European equity sales at Oddo.

“The ECB completely missed it, given the severity of the news flow, the actions taken were seen as very insufficient.”

The iTraxx European crossover CDS index, a gauge of the cost of insuring against defaults by junk debt issuers, rose as high as 596 bps, up over 50 bps after the ECB decision, according to Tradeweb.

“It’s helpful that the interest rate on TLTROs can be as low as -0.75%, so there is significant easing but no change in the headline interest rates, which is not good for the euro and highlights the limited ammunition that the ECB has left,” said Chris Scicluna, head of economic research at Daiwa.

Euro zone money market futures meanwhile scaled back expectations for future rate cuts, suggesting around an 80% chance of a 10bps cut by July.

Before the ECB decision, markets had positioned for two rate cuts by June.

Additional reporting by Saikat Chatterjee, Tommy Wilkes, Karin Strohecker and Julien Ponthus Editing by Sujata Rao, Giles Elgood/Susan Fenton