Bad news for EU growth is good news for bonds post ECB meet

By Virginia Furness

LONDON (Reuters) – Core euro zone bond yields struggled to find much uplift on Friday morning, a day after falling sharply due to downbeat comments from ECB President Mario Draghi who acknowledged weaker economic growth in the bloc.

Core euro zone bond yields fell to two-week lows after an ECB news conference on Thursday at which Draghi acknowledged key economic risks, ranging from trade wars to Brexit. This pushed back further the expectations of when the ECB will hike rates, fuelling the bid for bonds.

The yield on Germany’s 10-year government bond, the benchmark for the region, fell 4.6 basis points on Thursday, its biggest one-day drop since January 2..

French 10-year government bond yields also fell by almost five basis points to 0.59 percent, while Spanish 10-year government bond yields dropped 8.2 basis points, the biggest one-day fall since June, to 1.25 percent.

The comments will likely fuel market speculation that the bank will delay any rate hike, mirroring a more cautious approach by the U.S. Federal Reserve, and suggesting that the ECB’s outlook is increasingly aligning with market expectation.

“Draghi almost specifically validated that the market is pushing out next hike, so we favor curve flatteners,” said Antoine Bouvet, rates strategist at Mizuho.

The governing council expects key interest rates to remain at their present levels at least through the summer of 2019. But markets have already pushed out the first hike expectations to June 2020, wrote Shweta Singh, Managing Director, Global Macro at TS Lombard, in a note published on Monday.

“Draghi for many months has been telling us we are about to turn the corner in terms of inflation, but [yesterday] he was essentially on the back foot, and admitted that the risk is to the downside,” said Matt Cairns, rates strategist at Rabobank in London.

In addition to the scaling back of rate hike expectations, investors now expect a new round of cheap multi-year loans to banks, known as Targeted Long-Term Refinancing Operations (TLTRO), to be announced in March.

TLTROs would be especially beneficial to Italian banks, which explains the strong rally in Italian bonds, Bouvet said.

A rally in Italian government bonds gathered momentum with 10-year yields falling three basis points in early trade to 2.64 percent, extending the eight basis point fall seen on Thursday to opened at its lowest level since July 2018..

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