August 15, 2014 / 12:05 PM / 3 years ago

Bund yields hug 1 percent on weak euro zone outlook

(Updates prices, adds fresh comments)

By Marius Zaharia and Emelia Sithole-Matarise

LONDON, Aug 15 (Reuters) - German Bund yields held near their record lows around 1 percent on Friday, with investors increasingly betting the ECB will ease monetary policy further to lift a stagnating economy struggling with low inflation.

Data showed on Thursday the euro zone economy failed to grow in the second quarter even before the sanctions the West and Russia imposed on each other over the conflict in Ukraine started to bite.

Russian President Vladimir Putin struck a conciliatory note on Thursday in Crimea saying Moscow would stand up for itself but not at the cost of confrontation with the outside world.

However, tensions remained high in Ukraine, where Kiev government forces were fighting pro-Moscow separatists and dozens of heavy Russian military vehicles massed near the border.

Ten-year Bund yields were last 0.4 basis points higher on the day at 1.018 percent, having briefly dipped below 1 percent on Thursday, according to traders.

“We look for Bunds to hug the 1 percent yield ... not just for today, but rather longer,” Markus Koch, a Commerzbank analyst, said.

While the ECB is unlikely to take fresh measures in the next few months, many in the market say it will eventually have to embark on asset purchases, a monetary policy tool known as quantitative easing, as pressure mounts on it to act.

Against this backdrop, the market remained biased towards another downward lurch in Bund yields.

“If QE expectations do accelerate, expect sharper moves downward in Bund yields but if QE continues to be delayed, this will also benefit nominal bonds as the market will price mounting deflation risk and a central bank far behind the curve. Neither hurts core bonds,” RBS strategists said in a note.

Citing their own fair-value models which take into account inflation, private sector loan growth and manufacturing activity surveys, they said Bunds were not yet expensive at these levels. They said they only become so at a yield of 0.96 percent.

Not all in the market share this view. Didier Duret, chief investment officer at ABN Amro, said such ultra-low yield levels were reminiscent of the situation in Japan which is going through a period of prolonged subdued inflation and bond yields.

“At 1 percent you are bound for a negative real yield. This is Japan-like behaviour which we don’t buy here,” said Duret. He does not hold Bunds because “they are not attractive”. (Editing by Andrew Heavens)

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