LDN - Business

Euro zone bond yields fall as markets heed ECB's inflation message

[March 16, 2018] By Abhinav Ramnarayan and Dhara Ranasinghe

LONDON (Reuters) - Southern Europe led a fall in euro zone bond yields on Friday after another European Central Bank policymaker warned that inflation in the bloc remained sluggish, a potential hurdle to the withdrawal of monetary stimulus.

Portugal's 10-year bond yield fell to a seven-week low, while Italian yields were at their lowest in around five weeks.

Peripheral government bonds are among the biggest beneficiaries of the ECB's largesse and any sense that the bank may prove more cautious than expected in ending quantitative easing or raising rates tends to benefit these markets.

The currency bloc may have more unexploited capacity, particularly in the labor market, which could mean that inflation might take longer to rise back to the ECB's target of almost 2 percent, the bank's chief economist Peter Praet said on Friday.

This echoes remarks by other ECB policymakers including its chief Mario Draghi earlier this week.

"It's clear they are heading for the exit on QE but the discussion of them ending (bond) purchases in September is becoming less likely," said Marchel Alexandrovich, senior European economist at Jefferies.

"The take-away for us from this week's ECB speeches is that they are starting to use the term gradualism - the idea that at a time of uncertainty the right thing to do is move slowly in terms of monetary policy," he added.

Italian, Spanish and Portuguese government bond yields fell 2-5 basis points, more than the debt of better-rated peers. <IT10YT=RR> <PT10YT=RR> <ES10YT=RR>

The Italian 10-year government bond yield hit a five-week low of 1.94 percent, while Portugal's 10-year low fell as low as 1.73 percent and was set for its biggest weekly fall since November.

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European Central Bank (ECB) executive board member Peter Praet speaks during an interview with Reuters in Frankfurt, Germany, March 14, 2018. Picture taken March 14, 2018. REUTERS/Ralph Orlowski

Italy, where political parties are grappling to form a government after an inconclusive March 4 election, was in focus ahead of ratings reviews from Moody's and Fitch later on Friday.

The leader of Italy's eurosceptic League said on Wednesday a government deal with the anti-system 5-Star Movement was possible, raising the prospect of two radical groups running the country.

"Both ratings agencies have given negative comments in the past on what happens to Italy's future if anti-establishment parties come into power, both in terms of fiscal metrics and structural reforms," said DZ Bank strategist Daniel Lenz.

"It will be a close race as to whether they take ratings action."

Moody's rates Italy at Baa2 - just two notches above junk status - with a negative outlook. Fitch rates Italy as BBB with a stable outlook.

Germany's 10-year bond yield touched a fresh five-week low of 0.56 percent <DE10YT=RR>. It is down around 9 bps this week, set for its biggest weekly fall since August.

This week's dovish ECB comments on inflation helped push a key market gauge of long-term euro zone inflation expectations to its lowest in over three months <EUIL5YF5Y=R>.

Earlier, trading on many key European bond and stocks futures were delayed as the Eurex trading system was hit by technical problems.

(Editing by Andrew Roche)

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