April 30, 2020 / 1:00 PM / 2 months ago

UPDATE 2-Bonds rally, bank stocks extend losses as ECB eschews big moves

(Adds details, comments)

By Yoruk Bahceli, Elizabeth Howcroft and Dhara Ranasinghe

LONDON, April 30 (Reuters) - German bond yields fell further to 1-1/2-month lows and bank stocks extended losses after the European Central Bank held off from making big moves at its policy meeting on Thursday.

The ECB reaffirmed its already vast bond purchase scheme but introduced no significant new measures.

The bank said it would cut interest rates on its long-term loans for banks and launch a loan scheme called Pandemic Emergency Long-Term Refinancing Operations (PLTROs). But it did not change its conventional bond buying programme, or emergency purchases aimed at helping coronavirus-hit economies.

Some analysts had expected an extension of its purchases to issuers that recently lost their investment-grade credit ratings. But the ECB said it had not considered adding junk debt to its asset purchases.

“The decision to keep all other instruments unchanged shows that the ECB first wants to take stock of all recently taken measures. It probably also wants to keep some powder dry,” said Carsten Brzeski, chief economist for the euro zone and global head of macro at ING.

“And this dry powder is needed, as today’s GDP data has given us the first impression of how severe the crisis in the euro zone actually is,” he added, referring to a record contraction in the region’s economy.

Most euro zone bond rallied during the meeting. Germany’s benchmark 10-year bond yields declined to as low as -0.57% , the lowest since mid-March.

“Generally speaking it was a dovish press conference, the ECB is preparing the market for an expansion of QE,” said Marchel Alexandrovich, European financial economist at Jefferies, referring to the bank’s bond purchases.

Lagarde said the bank would make full use of flexibility embedded in its various policy tools.

Italian debt - the main victims of the bond market fallout in reaction to the coronavirus pandemic - showed a volatile response.

Italy’s two-year bond yields, which have been in focus given short-term risks from the coronavirus crisis, erased some gains and were down 8 bps at 0.56% after having fallen as much as 15 bps at the start of the conference.

Longer-dated Italian bonds sold off, with 10-year yields up 4 bps at 1.81%.

Jefferies’ Alexandrovich said the details of the ECB’s new PLTRO scheme may have supported short-dated Italian bonds. “The market is concluding that a lot of this money will flow into short-dated sovereign debt.”

The gap between Italy’s and Germany’s 10-year bond yields - effectively the risk premium Italy pays on its debt - widened to as much as 236 bps, its widest since Friday’s Italian ratings review by S&P.

Euro zone bank shares, which were already battered by disappointing results, underperformed sharply. They dropped as much as 6.5% after Lagarde said the ECB did not discuss buying junk bonds.

The euro fell slightly against the dollar as Lagarde spoke. It was at $1.084, down 0.3% on the day.

Reporting by the London Markets Team; writing by Yoruk Bahceli; editing by John Stonestreet

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