* Bunds steady after initial drop
* Market digests peripheral supply, bonds rally
* Eonia dips below Monday’s record low
* ECB’s Weidmann warns against govt bond buying
By John Geddie
LONDON, June 13 (Reuters) - German bond yields edged up on Friday, tracking UK equivalents higher after Bank of England Governor Mark Carney said interest rates could rise sooner than financial markets expect.
Bund futures fell as much as 43 ticks when markets opened, before recovering by the time cash markets opened. German 10-year bond yields rose 1 basis point to 1.4 percent.
“The Bund opened very weak but it is starting to come back a bit, showing that this first reaction was maybe somewhat an exaggeration of the European investors,” said Piet Lammens, strategist at KBC.
“The euro area should be a bit immune to UK rates, given the stance of the European Central Bank.”
While the BoE is gearing up to raise rates to cool its buoyant housing market and support economic recovery, the ECB has cut rates negative in a desperate attempt to stimulate bank lending and stoke low inflation.
While the connectedness of global economies could not prevent the euro zone debt benchmark from following its UK equivalent higher, it did manage to outperform by around 4 bps.
The BoE’s move had no impact on the euro zone’s lower-rated bonds, however, which all rallied as investors continued to show appetite for higher yields.
An escalating civil war in Iraq did little to dampen risk appetite, while the market appeared to easily digest a glut of new peripheral bond supply issued on Thursday which included 9 billion euros of new Spanish 10-year bonds, 8.5 billion euros of bonds sold at an Italian auction, and around 1 billion euros of a 10-year tap from Portugal.
Spanish, Italian and Portuguese 10-year bonds all inched 1 bps lower to 2.69, 2.81 and 3.37 percent, respectively.
In money markets, the overnight bank-to-bank Eonia lending rate EONIA= fixed at 0.043 percent, beating record lows set on Monday before the European Central Bank’s negative rate on deposits applied.
The ECB’s measure effectively penalises banks 10 basis points for holding their cash with the central bank overnight and is aimed at forcing banks to put their money to work, while keeping money market rates anchored at low levels.
The amount of cash euro zone banks have beyond what they need for their day-to-day operations is a key factor holding short-term rates low. Excess liquidity ECBNOMLIQ= stands at 112 billion euros, well above the three-year low of 70 billion euros hit at the end of last month.
Liquidity will be given a boost next week when the ECB stops withdrawing cash from the banking system to neutralise the effect of the bond purchases it made under the now defunct Securities Markets Programme (SMP).
It has also introduced 400 billion euros of ultra-cheap four-year loans for banks - conditional on their lending to the smaller companies that are Europe’s economic backbone - which will be available from September.
With forward Eonia rates dated for November and December showing an implied rate of around 0.03, there is clearly scope for money rates to fall further with these liquidity injections.
Hopes for a full-blown programme of government bond purchases from the ECB was dented late on Thursday, however, after Bundesbank President Jens Weidmann emphasised his opposition to them, calling them “sweet poison for governments” that undermine the central bank’s ability to do its job. (Editing by Alexandra Hudson)