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Record bond rally hinges on Draghi delivering a full QE package

London

MARIO Draghi needs to go out with a bang if he's to renew a surge in bond prices that sent yields to unprecedented lows.

Markets have factored in the European Central Bank's president slashing interest rates and restarting quantitative easing (QE), so it will take a multi-faceted stimulus package in his penultimate meeting on Thursday to impress investors.

Bond gains have faltered and the euro has staged a recovery from the weakest since 2017 this month after opposition from some officials raised doubts over the size and timing of any new asset purchases.

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Money markets are still betting on a 15-basis-point interest rate cut on Sept 12, a bigger drop than the 10 basis points forecast by economists.

Those expectations for policy easing to revive inflation have depressed the euro to US$1.10 and driven German bund yields well below the ECB's minus 0.4 per cent deposit rate.

"I think that the ECB will struggle to exceed the already dovish market expectations," said Valentin Marinov, head of Group-of-10 currency strategy at Credit Agricole SA.

Any failure to mitigate the fallout from even more negative rates on banks and to lift limits on the bonds the ECB can buy could spur euro gains to US$1.12, he said.

"Without them, people will conclude that Draghi is done and that the ECB may not have the courage for more once he is gone."

Goldman Sachs' strategists have stopped recommending bets on the euro's decline against the yen ahead of the announcement, while Morgan Stanley has scaled down its estimate for the size of future asset purchases.

That caution led European bonds to fall on Monday, the latest in a series of pullbacks from the rally.

Longer maturities have been worst hit, following poor demand in a 30-year German auction, as they would benefit the most from renewed ECB asset purchases.

Allianz Global Investors has warned of a bigger sell-off in German bunds.

"ECB expectations got too aggressive this summer. They may have more to correct," said Giles Gale, head of European rates strategy.

"The flurry of hawkish rhetoric was more of an attempt to dial-back over-ambitious market expectations and give some headroom for a dovish surprise, rather than a sea-change at the Governing Council. BLOOMBERG