October 2, 2019 / 11:14 AM / 19 days ago

UPDATE 2-Euro zone bond yields creep up, central bank doubts dominate

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices to close,)

By Yoruk Bahceli and Dhara Ranasinghe

LONDON, Oct 2 (Reuters) - Euro zone bond yields inched up on Wednesday in a counter-intuitive move after weak data releases this week, reflecting concern that the European Central Bank is running out of room to manoeuvre in the face of a weakening economy.

Yields fell on Tuesday after poor U.S. manufacturing data, then headed up again on Wednesday even as stock markets sold off. .

Analysts cited a number of reasons for the sell-off in bonds, which usually benefit from risk-off sentiment.

One is the persistent call by European Central Bank President Mario Draghi for more fiscal stimulus, fuelling concern that looser ECB monetary policy easing may have run its course.

Draghi on Tuesday said the most effective treatment for a sluggish economy would be investment-led stimulus at the euro zone level.

Divisions on the ECB board and questions about the efficacy of ECB policy have added to a sense that the bar to further policy easing is high, analysts said.

“If you don’t expect central banks to come to the rescue, bonds have no reason to go up massively,” said Stéphane Barbier de la Serre, a Makor Capital Markets macro strategist, referring to bond prices, which move inversely to the yield.

Germany’s 10-year benchmark bond yield is up 3.5 basis points this week, having fallen 6 bps last week on poor data releases.

It was 2.4 bps higher on Wednesday at -0.54% in line with a rise in most other euro zone bond yields and in contrast to a fall in U.S. Treasury yields.

Divisions at the ECB were highlighted by the latest comments from Bundesbank head Jens Weidmann.

Weidmann reaffirmed his opposition on Tuesday to relaxing the terms of the ECB’s quantitative-easing programme so that it can buy even more government debt.

“In the wake of the ECB meeting, we’ve got a sense that there is so much division on the ECB board so further easing will be difficult,” said Pooja Kumra, European rates strategist at TD securities.

Most 10-year government bond yields in the region were up 2-3 bps in late trade .

Analysts said euro zone bonds have also taken a cue from Japan. The Bank of Japan has been signalling it may ease policy further by pushing down short- and medium-term yields but still allow the yield curve to steepen at the longer end, which discouraged purchases at Tuesday’s auction.

Some weakness in British gilts also filtered through to euro zone bonds, with focus on a British government Brexit proposal.

Britain has proposed creating an all-island regulatory zone in Ireland to cover all goods and a commitment to avoid border checks or physical infrastructure in a bid to break the Brexit deadlock.

Meanwhile, the first quote for the ECB’s new benchmark rate ESTR was released at -0.549%, 9.8 basis points below the last EONIA reading.

Reporting by Yoruk Bahceli and Dhara Ranasinghe; additional reporting by Josephine Mason; editing by Larry King and Toby Davis

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