March 6, 2017 / 12:02 PM / 5 months ago

From politics to policy - bond markets count down to ECB

An illuminated euro sign is seen in front of the headquarters of the European Central Bank (ECB) in the late evening in Frankfurt January 8, 2013.Kai Pfaffenbach/Files

LONDON (Reuters) - Most euro zone government bond yields edged down on Monday, as a perception that the ECB will this week resist calls to start unwinding its ultra-loose monetary policy brought some comfort to markets that are bracing for an imminent U.S. rate hike.

The European Central Bank meets on Thursday and is not expected to make any changes to its monetary policy, highlighting a divergence with the United States, where comments in the past week from Federal Reserve officials have seen expectations for a March rate hike ratchet higher.

Remarks by Fed chief Janet Yellen on Friday cemented the view that the Fed is likely to raise interest rates when it meets on March 14-15.

The ECB faces a balancing act between signalling that it will keep monetary policy stimulus in place as contentious Dutch and French elections loom, while at the same time acknowledging stronger economic growth in the region and higher inflation.

Data last week showed inflation in the 19-member euro zone rose to 2 percent in February, zooming past the ECB's inflation target of close to but below 2 percent.

Investors will watch ECB President Mario Draghi for any change in his forward guidance, paying attention to whether he will drop the reference to keeping interest rates at their "present or lower levels for an extended period of time".

"There is a remaining risk that on the rates guidance, the ECB becomes a little less dovish," said Commerzbank rates strategist Rainer Guntermann.

"The news flow on inflation has certainly been positive, but on the other hand there are risks in the euro zone so it's probably too early to say there will be a consensus on the need for policy tweaks."

All About Guidance

Most euro zone bond yields edged down on Monday. Germany's benchmark 10-year Bund yield fell 2.5 basis points to 0.33 percent, off a two-week high hit on Friday.

It also drew support from a tumble in German stocks as Deutsche Bank shares slumped after the German heavyweight lender unveiled an 8 billion euro cash call.

Against a backdrop of stronger euro zone data and talk of another U.S. rate rise soon, money markets price in around a 60 percent chance that the ECB will hike its deposit rate by 10 basis points early next year.

A tapering of the ECB's bond buying stimulus is seen as a key risk for government bond markets and analysts say talk of policy loosening is still premature.

The ECB lowers its monthly asset purchases to 60 billion euros from 80 billion euros in April, keeping the bond-buying scheme in place until at least year-end.

"An announcement about the discontinuation of the quantitative-easing programme would be premature at the present time and not without danger, as the market's likely brutal reaction to the anticipated end of QE would be counterproductive to the ECB's goals," said Franck Dixmier, global head of fixed income at AllianzGI.

French Yields Higher

Elsewhere, French bond yields edged higher, pushing French/Germany 10-year yield gap out to 65 bps for the first time in five days after former French prime minister Alain Juppe said he was not prepared to be a candidate in the country's presidential elections.

Investors, worried that this made a victory by anti-EU leader Marine Le Pen more likely, also pushed the euro lower.

An opinion poll on Friday had suggested that if Juppe were to replace the beleaguered Francois Fillon as the centre-right candidate, he would win the first round of the election, with centrist candidate Emmanuel Macron coming second - a scenario that would knock Le Pen out of the race.

Editing by Catherine Evans and Ed Osmond

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