July 20, 2017 / 10:50 AM / 8 months ago

UPDATE 1-Euro zone bonds yield edge higher as ECB balancing act looms

* Analysts expect Draghi caution, but risks are to hawkish side

* Spain and France to sell government bonds via auctions

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Writes through)

By Abhinav Ramnarayan

LONDON, July 20 (Reuters) - Euro zone government bond yields edged higher on Thursday ahead of a European Central Bank meeting at which policymakers are expected to stick to their plans regarding the eventual unwinding of their asset-buying programme.

Most market participants expect the ECB to play something of a balancing act, keeping the course towards tightening steady while trying to avoid triggering serious market volatility.

“The ECB has to prepare the market for (an announcement of) reduction of bond-buying in the autumn, but it would be very surprising if it’s a very hawkish message,” said Gilles Pradere, a portfolio manager at RAM Active Investments.

“The message will likely be there’s no need to panic that the ECB will turn off the support tomorrow. They don’t want to fuel excessive optimism or panic. Generally (ECB chief Mario) Draghi is quite good at that,” he said.

Euro zone government bond yields have been rising ever since Draghi opened the door to policy tweaks in a speech in Sintra Portugal, on June 27.

This led most investors to bring forward their expectations for when the central bank would announce the reduction of its 2 trillion euro bond-buying scheme.

On Thursday, the yield on Germany’s 10-year government bond , the benchmark for the region, was higher 1.5 basis points to 0.55 percent.

Analysts will be watching Southern European government bond yields closely, as they are seen as the biggest beneficiaries of the central bank’s ultra-loose monetary policy stance of the past few years.

Yet the gap between their borrowing costs and that of Germany - the bloc’s benchmark - has actually been close to their tightest level in months.

“We have seen very little impact on peripheral spreads since Sintra but this could change very rapidly in a short period of time if the messaging is a bit too hawkish today,” said DZ Bank strategist Daniel Lenz.

“A new discussion on how Italy will cope with the high yield environment when tapering begins will start up, and this is something ECB needs to avoid by all means,” he said.

The gap between Italian and German 10-year borrowing costs was close to its lowest level all year at 163 basis points.

The Spain-Germany 10-year bond yield spread was also close to its tightest level since September 2016 at 99.7 bps.

Also on Thursday, Greece’s government bond yields rose after IFR reported that the country has hired six banks to manage a new debt sale.

Euro zone bond yields may have also come under upward pressure after Spain and France sold bonds via auctions on Thursday.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets

Reporting by Abhinav Ramnarayan; Editing by Andrew Heavens and Pritha Sarkar

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