October 16, 2017 / 11:16 AM / a year ago

UPDATE 2-Euro zone bond yields fall to 1-month lows, Spain recovers ground

* Most euro zone bond yields hit one-month low

* ECB ‘lower for longer’ taper expectations support market

* Allow Spanish bonds to recover ground from Catalonia jitters

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Recasts with late move in bonds)

By Dhara Ranasinghe and Abhinav Ramnarayan

LONDON, Oct 16 (Reuters) - Most bond yields across the euro zone fell to their lowest in around a month on Monday, pushed down by growing expectations that the ECB is moving towards extending its asset-buying scheme at a lower volume.

The broad rally in euro zone bond prices, which pushed yields down, allowed Spain’s bond market to recover from Catalonia-related jitters.

The Spanish debt market had lagged the rest of the euro zone for much of the session as Madrid moved towards direct rule over Catalonia, which held a banned independence referendum on Oct. 1.

Catalan authorities must drop a bid for independence by Thursday, the Spanish government said.

But as the session progressed, selling pressure in Spain’s government bonds abated, with yields reversing course to fall in line with the broader euro zone market.

Ten-year bond yields in Germany and Italy hit one-month lows, extending moves seen late last week on reports that ECB policymakers broadly agree to extend asset purchases at a lower volume at their October policy meeting with views converging on a nine-month extension.

That pushed Spain’s 10-year bond yield down 2 basis points to 1.57 percent, its lowest level in four weeks, according to Reuters data.

“We’re still really struggling to work out what’s the next step in Catalonia,” said Rabobank fixed-income strategist Lyn Graham-Taylor. “It would seem that the nine-month tapering scenario is supporting markets.”

Earlier, Catalonia jitters had briefly pushed out the gap between Spanish and German bond yields.

Spain’s IBEX share index lagged the broader European market, dropping almost 1 percent with financials weighing most. Spanish banks Caixabank, BBVA and Banco Sabadell were down 2 to 2.9 percent.

Across the euro zone, bond yields fell 2-4 basis points, with Germany’s benchmark 10-year bond yield hitting a one-month low of 0.37 percent.

That was in contrast to a rise in U.S. bond yields, which were pushed up after a stronger-than-expected report on manufacturing from the New York Federal Reserve.

U.S. and European bond markets often move in step with each other but the outlook for European Central Bank policy was in the driving seat for now.

Currently, the ECB buys 60 billion euros ($71 billion) of assets a month in a scheme that runs until the end of the year. That buying is expected to be scaled back given brighter economic conditions and technical constraints facing the programme.

“Draghi & co will get the opportunity to put market expectations right ahead of the blackout period,” analysts at Commerzbank said in a note, referring to scheduled appearances from top ECB officials in the days ahead. The ECB meets next week.

They expected German 10-year yields to establish a new range between 0.40 and 0.45 percent in light of changed policy expectations. ($1 = 0.8467 euros)

Reporting by Dhara Ranasinghe and Abhinav Ramnarayan; Editing by Dale Hudson

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