August 23, 2018 / 12:01 PM / 8 months ago

UPDATE 2-Euro zone bond yields hold up in face of modest economic growth

* PMI data points to lethargic Aug growth

* Weidmann seemingly out of ECB race, peripheral bonds find bid

* Euro zone periphery govt bond yields (Updates prices)

By Virginia Furness

LONDON, Aug 23 (Reuters) - High grade euro zone bond yields stayed off recent lows on Thursday after purchasing managers’ index data showed a moderate pickup in business growth.

Yields have moved off their lows in recent days on signs of improvement in the euro zone economy, but a mixed set of PMIs kept them mostly steady on Thursday.

IHS Markit’s flash euro zone composite PMI for August, seen as a good gauge of economic health, rose to 54.4 from 54.3 in July, although it was below the median forecast of 54.5 in a Reuters poll.

“PMIs were fairly market neutral,” said Christoph Rieger, head of rates and credit strategy at Commerzbank. “Given the broader market themes, they can’t give the market new direction.”

Euro zone bond yields all fell at the market open, though the moves were marginal.

Bonds of peripheral euro zone member states also found a bid on the expectation that Bundesbank chief Jens Weidmann is now less likely to succeed Mario Draghi at the helm of the European Central Bank.

German Chancellor Angela Merkel was reported by Handlesblatt to be focusing instead on securing the European Commission presidency for a German candidate.

Weidmann is considered the ECB’s most hawkish policymaker and were he to win the top job at the central bank expectations are he would push for faster rate increases.

“The risk of a more hawkish ECB president is mitigated, which suits the direction of spreads this morning,” said Commerzbank’s Rieger. “Investors will feel more comfortable holding periphery risk.”

Spanish and Portuguese government yields edged lower in early trade though Italian yields rose as the session wore on. ,,

Signs of improved economic growth in the euro zone had pushed the transatlantic spread, an indicator of how the monetary policy stances of the United States and the ECB are converging or diverging, to near its tightest level in two months.

The spread between German 10-year and U.S. 10-year Treasury yields opened on Thursday at 247.0 bps, before creeping up to 247.8 bps.

Annual inflation in the euro zone rose to 2.1 percent in July, which is above the ECB’s target, data showed last week.

While the August PMI data suggests lethargic growth, summer factory closures in France, Italy and Spain meant the PMI sample in some countries was smaller than usual and the data was unlikely to result in a change of course by the ECB, analysts said.

Signs of faster economic growth and inflation in the euro zone had seen German 10-year yields come off recent lows of 0.29 percent this week, before reaching 0.35 percent on Thursday .

Bund funding is set to rise in gross issuance by 10 billion euros across all instruments in 2019. Expectations of new supply kept a 10 bps widening in Italian spreads on Wednesday from turning into a stronger bid for Bunds, according to research by Commerzbank.

Minutes of the ECB’s July 26 meeting, released on Thursday, showed that policymakers believe protectionism and the threat of a global trade war are the biggest risks to the euro zone economy.

New tariffs imposed overnight by the United States and China may add to a bid for safe-haven assets such as German bonds. The two countries implemented 25 percent tariffs on $16 billion worth of each other’s goods; they have now imposed tariffs on a combined $100 billion of products since early July.

Global trade concerns had eased before a meeting between mid-level Chinese and U.S. government officials, but the additional tariffs have renewed concern that a trade war will hurt economic activity.

The 10-year U.S. Treasury bond has fallen from the highs of over three percent seen in early August to 2.82 percent on Thursday. ($1 = 0.8744 euros) (Reporting by Virginia Furness; Editing by Larry King, Susan Fenton and David Stamp)

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