LONDON (Reuters) - Euro zone government bond yields dipped on Tuesday as attention shifted from tensions over North Korea to an approaching European Central Bank meeting that could shed light on the timing for an unwinding of massive monetary stimulus.
The latest worries over North Korea’s nuclear programme have bolstered demand for safe bonds in recent weeks. Its sixth and most powerful nuclear test at the weekend lent further support to fixed income on Monday, but overall the impact has been limited. .
That in part, say analysts, suggests markets see the chances of a military conflict as low. It also reflects some caution against piling into bonds heavily before Thursday’s ECB meeting.
“The ECB meeting is still the key risk event for the week and the impact of geopolitics is fading,” said Commerzbank rates strategist Rainer Guntermann.
“A consensus has settled on the view that the ECB will indicate the exit is coming at some point but refrain from giving details.”
After shooting up in the wake of comments by ECB chief Mario Draghi in late June that were seen paving the way for “tapering”, government bond yields have headed back down.
In Germany, the bloc’s biggest economy and its benchmark bond issuer, 10-year bond yields were down 3 basis points on the day at 0.34 percent in late trade on Tuesday and about 25 bps below 18-month highs set in July.
Two-year German yields slipped 1.5 bps to -0.78 percent, their lowest in more than four months.
The fall in yields coincided with a drop in U.S. Treasury yields as U.S. traders returned after the Labor Day holiday.
The pull-back in bond yields has been aided by the euro, which hit 2-1/2 year highs above $1.20 a week ago.
A stronger currency, which dampens inflation by lowering the cost of imported goods, complicates the ECB’s exit from quantitative easing.
Minutes from the ECB’s July meeting reflected concern about currency strength -- a worry voiced again by some policymakers last week -- raising the chances that asset purchases will be phased out only slowly.
The euro trade-weighted index is up almost 5 percent this year, and has added just over 1 percent since the ECB’s July meeting.
“Strength in the currency will have downward pressure on the ECB’s inflation forecasts through to 2019, which should prevent any hawkish tone this week,” said Patrick O‘Donnell, an investment manager at Aberdeen Asset Management.
Yields on debt issued by lower-rated euro zone members, seen as prime beneficiaries of the ECB’s bond-purchase stimulus scheme, also fell. Italian 10-year yields slid below 2 percent for the first time since Aug. 8.
They were last down 5.3 bps at 1.993 percent.
The ECB is still expected to start winding down its stimulus early next year, given a stronger economic outlook and a scarcity of eligible bonds for the programme.
Data released on Monday showed the ECB bought fewer German bonds in August than in any month since the start of the stimulus programme, suggesting it was holding back to avoid running out of debt to buy.
Instead it has for several months been buying more French and Italian bonds than it is supposed to under the scheme.
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Reporting by Dhara Ranasinghe; Editing by Gareth Jones