January 23, 2020 / 4:53 PM / 6 months ago

Euro, bond yields plummet on cautious Lagarde tone, virus fears

LONDON (Reuters) - The euro fell to a seven-week low and German bond yields dropped to six-week lows on Thursday after European Central Bank President Christine Lagarde struck a slightly more dovish tone than some had expected.

Analysts cautioned against reading too much into the moves, noting they were also broadly tracking global markets where investors were selling stocks and buying safe-haven assets such as the yen and government bonds as fears grew about the spread of a respiratory virus from China.

New coronavirus cases in Singapore and Saudi Arabia rekindled memories of the 2002-2003 SARS outbreak that dented economic growth and caused hundreds of deaths around the world.

But the euro losses and the bond rally accelerated after Lagarde told a news conference that risks to growth in the euro zone remained tilted to the downside, though she said the bias had become less pronounced. The bank had earlier kept rates steady and launched a strategic policy review.

Germany’s 10-year bond yield, already down on the day, touched its lowest since Dec. 12 at -0.313% after the ECB news conference DE10YT=RR. It was last down 5 basis points.

Italian government bond yields also fell further and were down 10 bps in their biggest tumble since mid November. IT10YT=RR

The euro fell half a percent to $1.1036 EUR=EBS, its weakest since Dec. 2.

Gavin Friend, a strategist at National Bank of Australia said against the risk-off backdrop caused by the virus outbreak, Lagarde had disappointed markets which had expected a more upbeat tone, given trade war headwinds and geopolitical risks had abated since the last policy meeting.

“Going into the ECB, people thought it would be at least as optimistic as it was at the December meeting...The nascent optimism is still there. So it’s a question of getting that view through or is the market concerned she isn’t talking the economy up the way Draghi might have done,” Friend added.

Economists have been encouraged by positive data to believe euro zone activity has bottomed out. Money markets have started to price in higher ECB interest rates for next year and expectations are growing other central banks might try to emulate Sweden in raising rates out of sub-zero territory.

But Antoine Bouvet, senior rates strategist at ING, said Lagarde had “declined on a few occasions to distance herself from negative interest rates”.

That hit shares in euro zone banks which struggle to boost profit margins when rates are so low — the banking index fell as much as 1.1% to 1-1/2 month lows .SX7P.

(Graphic: Euro zone markets react to ECB news conference - here)

“The euro is not about to receive support from ECB policy any time soon,” Nordea analysts told clients.

The ECB also launched its well-anticipated strategic review, which Lagarde said was likely to take about a year, although she hinted it could take longer.

She declined to comment on what changes she might favour to the inflation target, but promised to “not leave any stone unturned”.

Some investors appeared disappointed with the meeting and the strategy review announcement.

“Today’s meeting was expected to be the hors d’oeuvre of the ECB’s policy review. In reality it was more akin to the notification that the ECB would be cooking dinner,” said Andrew Mulliner, portfolio manager at Janus Henderson.

Reporting by Dhara Ranasinge, Tommy Reggiori Wilkes and Thyagaraju Adinarayan; editing by Sujata Rao

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