* Spanish Aug inflation at -0.5 pct vs -0.6 pct fcast
* German inflation figures due at 1200 GMT
* Italy sells up to 8 bln euros of five- and 10-year bonds
By Marius Zaharia
LONDON, Aug 28 (Reuters) - Euro zone bond yields held at record lows on Thursday as a drop in Spanish inflation in August kept pressure on the European Central Bank to ease policy further.
Spanish inflation came in at minus 0.5 percent, higher than expectations of minus 0.6 percent but lower than in July. German inflation due at 1200 GMT was expected to be unchanged at 0.8 percent.
Overall, inflation in the euro zone is still sure to remain far from the ECB’s target of just below 2 percent. Data for the region as a whole is due on Friday and is forecast to slip to 0.3 percent from 0.4 percent.
Such data is increasing speculation that the ECB will follow in the footsteps of the world’s other major central banks and start pumping money into the flagging euro zone economy via an asset-buying programme, known as quantitative easing (QE).
In a landmark speech on Friday, ECB President Mario Draghi highlighted a “significant” fall in euro zone inflation expectations this month, dropping his strongest hint yet that a QE programme is possible over the next year.
“For the euro area, inflation may now be 0.3 or 0.4 percent but I don’t think this one figure is of major importance,” said Piet Lammens, a strategist at KBC in Brussels.
“What is important is that Draghi said that during August inflation expectations have dropped substantially.”
German 10-year yields were last a touch lower on the day at 0.907 percent, just above a record low of 0.896 percent on Wednesday.
Most other euro zone yields were near their record lows, with Spanish 10-year bonds yielding 2.14 percent and the Italian ones yielding 2.38 percent.
ECB sources said that the central bank is unlikely to take new policy action next week unless August inflation figures show the euro zone sinking significantly towards deflation. link.reuters.com/fug72w
The five-year, five-year forward breakeven rate - the ECB’s preferred measure of what the market thinks the inflation outlook is - has picked up since Draghi’s speech in Jackson Hole.
The rate, which now shows roughly where investors expect forecasts of inflation for 2024 to be in 2019, had fallen by roughly 20 bps in less than a month before those remarks and was approaching its 2010 record lows of around 1.90 percent. It has since picked up to a shade above 2 percent.
Other measures still show very low long-term inflation expectations. Ten-year inflation swaps stand at 1.5 percent, while five-year swaps trade at 1 percent.
Two-year German breakeven rates, derived from the yield gap between conventional and inflation-linked bonds, are negative. Ten-year breakeven rates at 1.26 percent are not far from Japan’s 1.18 percent.
Low inflation or deflation may create problems for the euro zone’s lowest-rated economies’ efforts to cut their debts. However, QE prospects make those bonds attractive at this stage as the market sees the ECB as a likely heavy buyer at any price.
This, coupled with investors receiving coupon payments, is expected to ensure a smooth sale of up to 8 billion euros in five- and 10-year Italian bonds (BTPs) later in the day despite yields being at record lows.
“The BTP market remains firmly supported by various factors, not least growing expectations of further action by the ECB,” Citi strategists said in a note. (Graphics by Vincent Flasseur, editing by Nigel Stephenson)